In this issue - Milken Institute · PDF fileincluding a ground-breaking index of the best performing cities on the continent. ... fundamentals have improved, ... netic engineering

The M

ilken In

stitute Review • Fou

rth Q

uarter 2014 • volume 16, n

umber 4

jason furman On inequality

The poor need not always be with us.

dani rodrik On Africa’s economic prospects

Don’t pop the champagne corks just yet.

robert looney On Puerto Rico’s economic nosedive

Does bankruptcy loom?

matt phillips On Korea’s system for housing finance

Too clever by half?

robert moffitt On America’s safety net Could be a lot worse…

larry fisher On state franchise laws

Government as the enemy of competition.

jayson lusk On Frankenfood

Misunderstood, like the monster.

rob atkinson On driverless cars

The Jetsons are at the door.

In this issue

Challenging Inequality

Fourth Quarter 2014Fourth Quarter 2014

The Milken Institute Review • Fourth Quarter 2014

volume 16, number 4

the milken instituteMichael Milken, ChairmanMichael L. Klowden, CEO

Paul H. Irving, President

publisherConrad Kiechel

editor in chiefPeter Passell

art directorJoannah Ralston, Insight Designwww.insightdesignvt.com

managing editorLarry Yu

ISSN 1523-4282

Copyright 2014

The Milken Institute

Santa Monica, California

The Milken Institute Review is published

quarterly by the Milken Institute to encourage

discussion of current issues of public policy

relating to economic growth, job creation and

capital formation. Topics and authors are selected

to represent a diversity of views. The opinions

expressed are solely those of the authors and do

not necessarily represent the views of the Institute.

The Milken Institute’s mission is to improve lives

around the world by advancing innovative

economic and policy solutions that create jobs,

widen access to capital and enhance health.

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Claudia D. Goldin

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2014 | November 16-18Grand Hyatt Hotel, New York City

Be a part of medical research’s most forward-thinking, outcomes-oriented, and patient-focused event.

Convened by FasterCures, the DC-based center of the Milken

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c o n t e n t s

1Fourth Quarter 2014

23

from the ceo

editor’s note

5

29

trendsTesla short circuits.

by Lawrence Fisher

the spine, revealed

95

96

institute newsCup runneth over.

lists

inclusive growthGood news, for once. by Jason Furman

in defense of frankenfoodsNo pain, much gain.by Jason Lusk

why an african growthmiracle is unlikelyReality check.by Dani Rodrik

the social safety net in the great recessionCoulda been worse…by Robert A. Moffitt

16

30

42

55

austerity in thetropicsPuerto Rico in a bind.by Robert Looney

the comingtransportation revolutionSelf-driving cars.by Robert D. Atkinson

keeping up withthe jeonse Korea’s weird housing finance.by Matt Phillips

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2 The Milken Institute Review

f r o m t h e c e o

“Think global, act local,” is a popular catchphrase. But at the Milken Insti-

tute, our operating philosophy is “think global, act global,” for increasingly,

our engagement spans the world. Here are a few examples:

• In September, the Institute held its inaugural Asia Summit in Singapore.

Organized by our new, Singapore-based Asia Center, the meeting brought

together leaders from the worlds of business, finance, government and phi-

lanthropy to discuss issues ranging from Asia’s new crop of political leaders,

to the prognosis for health innovation in Asia, and to prosperity and risk in

the Asia-Pacific region. Our work in the region extends beyond convening

meetings: on the eve of the Summit, we released several major research reports on Asia,

including a ground-breaking index of the best performing cities on the continent.

• In late October, we return to the U.K. for our fourth London Summit, a one-day ver-

sion of our Global Conference. We will gather nearly a thousand participants from Eu-

rope, Africa, Asia and the Americas for panels and private sessions that will focus on find-

ing solutions to some of the globe’s biggest challenges.

• Our work in Africa continues to expand. As the continent with the most rapid growth

in the past decade, there are clearly huge opportunities to unlock the human capital and

creative potential of tens of millions of people. We are helping governments in East Af-

rica develop policies that attract growth-inducing foreign investment, as well as helping

multinational businesses better appreciate why they need an Africa strategy if they don’t

already have one.

• Last but hardly least, our Global Conference, held each spring in Los Angeles, is more

global with each passing year. We’re already planning for GC 2015, and expect to have

more international participants and speakers than ever before, and more panels centered

on issues of interest outside the United States.

Why is the Milken Institute so focused on expanding activities around the world? Not

only are the issues we focus on – expanding access to capital, improving health, helping

fuel job creation – intrinsically global in nature, but in an ever-more-borderless world, so-

lutions and innovations pioneered in one country can powerfully help people elsewhere.

A big part of what we do, especially through our convening, is a kind of cross-pollination

of ideas. By bringing innovators and leaders from many sectors and countries together,

we raise the odds that innovations will move around the world faster, and affect more

lives for the better.

Michael Klowden, CEO


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And anyway, along with the usual bad news bears, we’re offering pretty good tidings re: inequality, technology and the govern-ment safety net.

• Jason Furman, chair of President Obama’s

Council of Economic Advisers, argues that rising inequality could be reversed without sacrificing productivity or growth. “Modern economics has long been in the thrall of the view that virtually any interference with free

“What with war,drought, racial violence and terrorism haunt-

ing the news,” writes battle-fatigued correspondent JG from Passadumkeag, Maine,

why can’t you lighten up a bit?” Well, we’ve been wondering that ourselves, JG. We

were considering shifting media this issue so we could share our favorite cute animal

videos from YouTube, but guilt kicked in. (BTW: Don’t miss the duckling and kitten

sleeping together, or the manatee drinking water from a hose…)


market incentives with the goal of a more progressive distribution of income – policies ranging from higher taxes on high-income earners to minimum wage increases to subsi-dized medical care for the poor – would exact a price in economic efficiency,” he writes. In fact, “there is just no compelling reason to be-lieve well-designed policies to narrow this widening gap would meaningfully reduce growth, and every reason to believe they could provide a meaningful boost to working families.”

• Dani Rodrik, an economist at the Insti-tute for Advanced Study in Princeton, offers a reality check on the new optimism about Af-rica’s economic prospects. “While the region’s fundamentals have improved, the payoffs to macroeconomic stability and improved gov-ernance are mainly to foster resilience and to lay the groundwork for growth, rather than to ignite and sustain it,” he warns. “The tradi-tional engines behind rapid growth and con-vergence – structural change and industrial-ization – are operating at less than full power.”

• “Optimists can make a case that the safety net works – that tens of millions of Ameri-cans who suffered during the recession were buffered against the worst of it,” writes Robert Moffitt, an economist at Johns Hopkins. “But there is also a case to be made that this glass is half empty: Washington has no plans for helping those permanently injured by this re-cession, the millions of long-term unem-ployed who are not likely to work again either because their skills are marginal or their résu-més have been tainted by years of joblessness.”

• State franchise laws have long served to protect incumbent businesses from the winds of change, concludes Larry Fisher, a former New York Times reporter. “But this sleeping dog may not snooze indefinitely,” he writes.

“A light has been shown on these hitherto ob-

scure laws, thanks in part to Tesla Motors’ high-profile effort to sell its electric cars through company-owned stores – much as Apple sells iMacs and iPhones.”

• Puerto Rico’s economy is poised on the edge of the abyss, warns Bob Looney, an economist at the Naval Postgraduate School in California. “With the public utilities im-mobilized by debt and island businesses forced to pay wages unjustified by productiv-ity gains, there is little hope that operating costs can be controlled,” Looney writes.

“There is, however, a modest source of hope” in the form of business-friendly local govern-ment initiatives and the commonwealth’s re-maining tax advantages.

• Cars that drive themselves are poised to disrupt business as usual, acknowledges Rob Atkinson, the president of the Information Technology and Innovation Foundation. But “the direct productivity gains are likely to be modest,” he writes. “The bulk of the gains will come from reducing the costs associated with accidents and traffic congestion.”

• Genetically engineered crops may spook the technophobic, argues Jayson Lusk, an economist at Oklahoma State University. “But given the confluence of tightening water sup-plies, climate change, rising demand for meat in emerging-market countries like India and China, and a growing world population, ge-netic engineering will be necessary if we are to feed future generations at reasonable cost.”

• South Korea’s unique Joense system for fi-nancing housing served as a secret weapon in that country’s dramatic rise to prosperity, writes Matt Phillips, a former reporter for the Wall Street Journal. But as Korea faces the stresses of affluence “the dynamic has changed,” he explains, undermining house-holds’ incentives to save and putting the economy in peril of a major housing bust.

Happy perusing. — Peter Passell

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Lawrence M. Fisher writes about business for The New York Times and other publications.

More often than not, state regulation of business practices impedes innovation, raises costs and distorts markets. Most of these rules predate the Internet – indeed, some pre-date the revolution in commerce that brought us everything from direct marketing to big-box stores. However, they remain on the books, invisible to consumers and protected by the lobbying dollars of the incumbent businesses they protect.

But this sleeping dog may not snooze in-definitely. A light has been shown on these hitherto obscure laws, thanks in part to Tesla Motors’ high-profile effort to sell its electric cars through company-owned stores, much as Apple sells iMacs and iPhones. Auto deal-ers, who once derided electric cars as niche vehicles for tree huggers, now view the Silicon Valley upstart as a threat and have used fran-chise laws to block Tesla’s direct sales in nu-merous states. The goal is to protect local dealers from competition that would erode their market – and, in the best traditions of modern capitalism, force them to be more cost-effective and service-oriented.

Like the various laws that protect and sub-sidize the “family farm” – you know, those 2,000-acre grain factories run by mom, pop

When are blatantly anticompetitive acts not a violation of antitrust laws?

When lawmakers say so.

Q:A:

b y l a w r e n c e f i s h e r


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ksIYour Friendly Neighborhood Automobile Trust

In the first two decades of the 20th century, the auto industry distributed its products every way imaginable. Cars were sold directly through factory stores, mail order and con-signment, and indirectly through department stores, traveling salesmen and wholesale dis-

tributors – and even through the Sears catalog. But as supply caught up with demand, the hodgepodge began to rationalize. From 1923 to 1929, “the leveling of demand for new cars logically resulted in a change of emphasis from production to distribution,” wrote Alfred P.

and $4 million worth of machinery – state economic regulation is rooted in historical circumstances. Indeed, it may have been jus-tifiable in economic terms at one time. For example, a century ago it was arguably a good idea to protect grieving families of the dead from fly-by-night embalmers by licensing fu-neral directors. It makes no sense today to use such laws to block inexpensive crematoriums or online casket sales. (More about that later.)

By the same token, the small businesses that sprang up to distribute automobiles in the 1920s may have needed protection from manufacturers who demanded big local in-vestments, yet felt free to cancel the relation-ships or establish other dealers a few miles away. But today’s corporate multibrand deal-erships can take care of themselves without help from Big Brother. And they certainly can’t justify using their legal muscle to pre-vent Tesla from competing directly in terms of either fairness or efficiency.

Meanwhile, the three-tier distribution sys-tem for alcoholic beverages – producers must sell to distributors who sell to retailers – is a states-rights legacy of the repeal of Prohibi-tion and clearly did not anticipate the blos-soming of boutique wineries, microbreweries and artisan spirits makers in the last two de-cades that target national and international markets through the Internet.

But a puzzle lurks. When Borders and Barnes & Noble decimated the ranks of inde-pendent bookstores – and when Amazon subsequently ate the chain stores’ lunch on the Internet – there was plenty of teeth gnash-ing, but no legislation. When the specialized dealers in PCs, like CompUSA, MicroAge and Businessland, were undone by big-box con-sumer electronics stores like Best Buy, Apple’s glitzy stores and Dell’s direct-to-consumer approach, there was little outcry. How, then, have some incumbent businesses successfully commanded state protection from what the economist Joseph Schumpeter famously called creative destruction?

The short answer is that independent booksellers lacked the deep pockets and orga-nizational strength of the National Automo-bile Dealers Association. The laws protecting business turf are primarily state, not federal, statutes. And any Johnny-come-lately who seeks to come between state legislators and their benefactors among the car dealers is likely to face a cold reception. Lobbyists for the dealers are quick to note that they are pil-lars of the community who sponsor Little League and the Kiwanis Club’s charity drives. Equally to the point, they are also big donors to political campaigns. Woe betides the politi-cian who crosses them on behalf of some out-of-state competitor spouting the virtues of competition.

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Sloan Jr., the godfather of General Motors. “On the [retail] sales end, that meant a change from easy selling to hard selling. Dealer prob-lems of an entirely new nature began to arise.”

Manufacturers took over wholesale distri-bution, while wholesalers morphed into re-tailers. These franchised dealers took on war-ranty repair and regular maintenance, and provided a means to trade in used cars for new ones. They were contractually obliged to invest in service facilities and were expected to maintain significant inventories so that buyers could drive home new cars the same day they shopped. Dealers, moreover, be-came vulnerable to “channel stuffing” – being forced to take on more inventory than they could possibly sell at a profit – a manipulative strategy reportedly pioneered by Henry Ford in the 1920’s.

Dealers sought succor in new laws. “The car dealers went about getting protection after the Great Depression. But it’s in the 1950s that we start seeing regulations like the Automobile Dealers Day in Court Act,” which increases dealers’ leverage to seek damages in federal court for abuses of franchise agreements, ex-plained Francine Lafontaine, a professor of business economics and public policy at the Ross School of Business at the University of Michigan. “Maybe at some specific time there was a benefit, but then these dealers became entrenched. The results are higher prices for consumers at the end of the day.”

Although the act is a federal statute, most of the laws protecting franchise dealers were passed at the state level. Lafontaine says that the state laws have been successfully used to block manufacturers from canceling dealer-ships because of falling demand, as after the 2008 financial crisis, or in response to cus-tomer complaints or shady behavior. All states require auto dealers to be licensed,

which has effectively stymied Internet distri-bution of cars. Thus, sites like Carsdirect.com and Cartelligent.com (as well as brick-and-mortar enterprises like AAA and Costco) do not sell cars, but rather negotiate discounts with franchise dealers.

The licensing requirement also effectively blocks auto manufacturers from selling di-rectly to consumers because most states will not license them as dealers. As long as there were no new entrants in auto manufacturing, which was the case for many decades, this re-quirement protected the franchisees’ legal cartel.

When Tesla launched its $109,000 Road-ster in 2008, the conventional wisdom was that the latest coming of electric cars would fail just as earlier iterations had, fatally handi-capped by high battery cost and short driving range. Never mind that the speedy two-seater went 200 miles on $5 worth of electricity. Tesla sold the Roadster direct to customers – at first from the factory, later through a few stores. But the dealers’ lobbies didn’t pay much attention because it was a pricey vehicle that would appeal only to rich greenies.

Perceptions changed a bit with the intro-duction of the Tesla Model S, a sleek $70,000 sedan aimed squarely at the Audi/BMW/ Mercedes crowd. And alarm bells truly sounded when Consumer Reports gave its highest rating ever to the S, and the electric newcomer charted sales exceeding the com-parable conventional models from that Teu-tonic triumvirate. As Tesla stores started opening across the United States and abroad, franchise dealers circled the wagons and called their state legislators.

As this is being written, Tesla has store-fronts in 22 states and Washington, D.C., in spite of the fact that 48 states have laws that limit or ban manufacturers from selling vehi-cles directly. Meanwhile, dealership associa-

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http://www.herzogcrebs.com/News-Information/2007-Articles/The-Long-and-Winding-Road-Journal-of-Missouri-Bar-May-June-2007.pdf

http://www.herzogcrebs.com/News-Information/2007-Articles/The-Long-and-Winding-Road-Journal-of-Missouri-Bar-May-June-2007.pdf


tions in multiple states have filed lawsuits against Tesla, trying to kill the infant in its crib – or at least to get Tesla to put the crib under their protection. In states that prohibit direct sales, like Virginia and Texas, Tesla op-erates “galleries,” which resemble its stores. But they cannot take orders, or even discuss price and financing options.

Texas has the most stringent law, requiring all new cars to be purchased through inde-pendent dealers. Texans may still purchase ve-hicles from Tesla, but the transactions must be handled out of state. This may result in loans with higher interest rates and the in-ability to finance Texas state sales tax owed as part of the car loan. Also, buyers cannot take advantage of Tesla’s personal delivery service. New owners, moreover, must register the ve-hicles and pay the sales tax themselves.

Tesla’s effort to persuade the Texas legisla-ture to open the door to direct sales may not prove as futile as one might expect. Indeed, Tesla’s strategy of demanding marketing con-cessions from states if they are to have any chance of inducing Tesla to build production facilities in their jurisdictions suggests why the dealers’ market power may be vulnerable. Texas is one of five states lobbying to be the site of Tesla’s planned $5 billion mega-factory, where it will mass-produce lithium-ion bat-teries in partnership with Panasonic.

New Jersey, which initially licensed Tesla

stores, abruptly switched sides in March. Elon Musk, Tesla’s chairman and chief executive, wrote an open letter to New Jersey citizens, asserting that, after initially promising to put the matter to a vote by the state legislature, Gov. Chris Christie caved to the auto dealers.

Musk did not mince words. “The rationale given for the regulation change that requires auto companies to sell through dealers is that it ensures ‘consumer protection,’ ” he wrote.

“If you believe this, Governor Christie has a bridge closure he wants to sell you! Unless they are referring to the Mafia version of ‘pro-tection,’ this is obviously untrue. As anyone who has been through the conventional auto dealer purchase process knows, consumer protection is pretty much the furthest thing from the typical car dealer’s mind.”

In May, dealers in Missouri took dead aim at Tesla, proposing amendments to another bill that would force consumers to purchase all new vehicles through franchised dealers. The current Missouri statute only bars fran-chisors from competing against their franchi-sees. Ford, for example, cannot compete with Ford dealers.

All this activity at the state level has not gone unremarked in Washington, where three members of the FTC’s professional staff weighed in. In a blog post titled “Who decides how consumers should shop?” Andy Gavil, Debbie Feinstein and Marty Gaynor turned a

As this is being written, Tesla has storefronts in 22

states and Washington, D.C., in spite of the fact that 48

states have laws that limit or ban manufacturers from

selling vehicles directly. Meanwhile, dealership asso-

ciations in multiple states have filed lawsuits against

Tesla, trying to kill the infant in its crib.

http://www.ftc.gov/news-events/blogs/competition-matters/2014/04/who-decides-how-consumers-should-shop


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IThe American Way of Funerals?

In 2011, David Harrington, a professor of economics at Kenyon College, testified on be-half of the monks of St. Joseph Abbey who were barred from selling their handmade wooden caskets in their home state of Louisi-ana because they were not licensed funeral di-rectors. The monks won their case in federal court. But similar laws remain on the books in many states.

“In the states that have the most restrictive

laws,” Harrington said, “they’re primarily aimed at protecting small, mostly family-owned funeral homes from competition. They create barriers to entry for no-frills cre-mation operations – but also for national chains, which tend to focus at the high end, with more pricey funeral and cemetery com-binations.”

State funeral home licensing requirements largely date to the early 20th century. Initially,

gimlet eye toward the dealers. “How manu-facturers choose to supply their products and services to consumers is just as much a func-tion of competition as what they sell – and competition ultimately provides the best pro-tections for consumers and the best chances for new businesses to develop and succeed,” they wrote. “Our point has not been that new methods of sale are necessarily superior to the traditional methods – just that the deter-mination should be made through the com-petitive process.”

NADA, the aforementioned dealers’ trade association, begs to disagree. “State franchise laws create fierce competition between local new-car dealerships, which drives down prices both within and across brands,” said Jonathan Collegio, vice president of public af-fairs for NADA. “When three Ford dealers compete for the same customer, the customer wins, period.”

Not so fast, say economists, some 70 of whom wrote a letter to Christie urging an end to the direct sales ban:

The automotive industry in the United States (and New Jersey is no exception) is com-petitive; no manufacturer has anything like a monopoly. Tesla in particular, as an upstart

new entrant, has a market share in New Jersey of less than 1 percent. But even if Tesla did have a degree of market power sufficient to extract monopoly prices, prohibiting direct distribution would not be likely to introduce more competition or lower average prices.

“The likelihood that Tesla will successfully convince federal courts to invalidate the vari-ous state auto dealer franchise laws in their entirety is remote,” opined Roger M. Quin-land, a franchise law attorney with Gordon & Rees. “Tesla’s greatest chance for success lies in convincing the courts that narrow exemp-tions from state regulations should be tai-lored for the company, based upon its unique status in the automotive marketplace.”

In any case, the very visibility of the battle may prove a win for Tesla, whatever courts and legislatures decide. “As Tesla’s dealer fight rages on, the company gets plenty of press that enables it to explain what’s unique about its approach to selling vehicles,” the online invest-ment site Motley Fool wrote, noting that Tesla does not advertise. Tesla’s vice president of business development, Diarmuid O’Connell, concurs. “I think that it’s been extraordinarily rewarding,” he told The Wall Street Journal.

“It’s been vastly worth the effort.”

http://www.ij.org/saint-joseph-abbey-et-al-v-castille-et-al

http://www.laweconcenter.org/images/articles/tesla_letter_icle.pdf

http://www.fool.com/investing/general/2014/05/12/teslas-dealer-battle-a-boon-for-investors.aspx


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Harrington says, they were motivated by health concerns. Some experts believed that cemeteries caused epidemics and that the spread of disease could be reduced by em-balming. In the 19th century, families had typically prepared the dead for burial them-selves, making their own caskets or purchas-ing them from local carpenters, and arrang-ing delivery to the cemetery with whoever owned a suitable carriage. Early regulations were intended to protect the public from poor-quality embalming, but also served to impart professional status to funeral home operators and spare them price competition.

Today, embalming is most associated with the traditional funeral, which calls for the body’s display in an open coffin. But 39 states have ready-to-embalm laws that require all firms offering funeral services to maintain an embalming room at each of their facilities, re-gardless of whether they offer embalming services. Embalming rooms must conform to strict size and material standards. So these laws significantly increase costs to firms spe-cializing in cremations – and also to funeral home chains, which might otherwise realize economies by consolidating their embalming facilities in single locations.

Many states prohibit cemeteries from op-erating mortuaries, some prohibit anyone

other than licensed funeral directors from selling caskets, while others make it difficult for anyone other than funeral directors to own funeral homes. All of these measures cre-ate barriers to competition and increase costs.

That’s hardly a new revelation: Jessica Mit-ford’s seminal work, The American Way of Death (1963), portrayed funeral directors as predatory salesmen pushing grieving cus-tomers into overpriced goods and services, an image that has been reinforced by subsequent analyses. A decade-long study by the FTC re-sulted in the federal Funeral Rule of 1984, which mandated more transparent pricing and no-frills options. But funeral costs have continued to rise.

Harrington blames state regulations. “It’s like a spider’s web,” he said. “The states that are the most anticompetitive have all these strands of regulation, and they weave this web so they have redundancy of regulation. If you remove one strand, the web still holds. The funeral directors’ associations in a lot of states are among the most powerful lobbying organizations. Local funeral home operators are very heavily involved in their churches. And if you look at subcommittees or commit-tees in state legislatures, they are headed by representatives who are currently funeral di-rectors. They have pretty much a lock on blocking any reform.”

Law of Unintended ConsequencesIn 1933, the 21st Amendment repealed the 18th Amendment to the U.S. Constitution, thus bringing an end to the 14-year socio-biochemical experiment known as Prohibi-tion. It’s worth noting that the prohibition of alcoholic beverage sales did reduce consump-tion, the stated aim of the ungainly coalition

of do-gooders and religious fundamentalists that spurred passage of the law. But it had myriad unintended consequences, including the growth of organized crime, a sharp in-crease in deaths from tainted booze and the criminalization of broad swaths of society. It also increased social and economic inequality:

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The wealthy could maintain private stocks of imported wine and spirits with impunity while the poor were jailed for making bathtub gin. (Any resemblance to current drug policy must surely be coincidental.)

The authors of the 21st Amendment paid lip service to the temperance movement’s goal of reducing alcohol abuse. But they left the details to the states, giving them authority to decide when and how to organize and reg-ulate alcohol sales. All of them enacted regu-lations in which single ownership of all three tiers (production, distribution and retail) was partly or totally barred. Only Washington, a wine-making state, has since entirely aban-doned the three-tier approach (in 2011).

Arguably, the three-tier system worked reasonably well in the first few decades after repeal, which saw the consolidation of count-less regional beer, wine and spirits producers into big national brands and the simultane-ous proliferation of wholesale distributors. Then the process began to reverse, first in the 1960s with the emergence of boutique winer-ies, then typified by Robert Mondavi, Ridge Vineyards and Freemark Abbey; later in the 1970s with the first microbrewers like Anchor, New Albion and Sierra Nevada; and in the 1980s with craft distillers like Germain-Robin, St. George Spirits and Clear Creek Distillery. The distribution tier went through consolida-tion during these decades so that today there are far fewer, but vastly larger, distributors. Small producers say they struggle even to be noticed and get lost in the big distributors’ portfolios, all the while surrendering profits they can’t spare.

“State laws continue to empower distribu-tors to select brands and manage them how-ever they want – selling those they choose to sell, while letting other brands sit in their warehouses,” wrote Steve Hindy, president of

Brooklyn Brewery. “The only recourse is to sue, and many small breweries lack even a fraction of the resources needed to take on a big distributor in court. As a result, they’re stuck with the bad distributor, which severely hampers their ability to perform and grow as a business.” Freeing his brewery from a par-ticular distributor cost him more than $300,000 in legal fees and settlement charges.

State laws have also prohibited wineries from shipping their products directly to con-sumers, which can often be the only way a small operation can survive. Court challenges have chipped away at these laws. Most nota-bly, in 2005, the Supreme Court decided that, while states could prohibit direct shipments of wine, they could not simultaneously allow direct sales by in-state wineries and bar im-ports from other states.

“As a general matter, the wine producers fa-vored direct shipment,” explained Jerry Ellig, a senior research fellow at the Mercatus Cen-ter at George Mason University, and a former FTC official. “The big California wine indus-try was not really worried about competition from Kentucky or Virginia. The two folks who tended to oppose it were states that had these laws, and wine and spirits wholesalers. They generally would oppose anything that would allow people to get around the distri-bution tier.”

Ellig studied wine prices before and after Virginia passed a law permitting direct sales. “We found that the spread between online and off-line prices diminished,” he said.

But distributors retain significant clout. “Together, the nation’s two largest wholesalers – Southern Wine and Spirits and Republic Na-tional Distributing Company – have revenues of about $13 billion,” David White, editor of the wine blog Terroirist, wrote in The New York Times. “A chunk of that cash is funneled to lawmakers. The National Beer Wholesalers

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http://www.nytimes.com/2014/03/30/opinion/sunday/free-craft-beer.html?_r=0

http://www.law.cornell.edu/supct/html/03-1116.ZS.html

http://mercatus.org/publication/case-state-wine-shipping-laws

http://www.nytimes.com/2011/04/04/opinion/04white.html


RAssociation maintains the nation’s third-larg-est political action committee, and since 2000, it has donated $15.4 million to candidates for federal office. … In the past decade … the

Wine and Spirit Wholesalers of America spent $9.3 million.” All told, he estimates that anticompetitive regulation of distribution in-creases retail prices by as much as 25 percent.

The Fill-in-the-Blank Industry Is DifferentRegulation, in general, is deeply unfashion-able among owners of small to midsize busi-nesses. Except, of course, when it comes to regulation that protects incumbent enter-prises. Automobile sales, alcoholic beverage distribution and funeral services share little in common, yet incumbents in each claim they are uniquely deserving of special favor.

Jonathan Collegio of NADA took particu-lar exception to my suggestion that small bookstores or PC dealers ought to have sought sanctuary in state law. “It’s a major fallacy to compare buying cars with buying other goods, like books or computers,” Colle-gio said. “Cars are major purchases that re-quire licensing, insurance, complex financing involving trade-ins; contain hazardous mate-rials; and, if operated incorrectly, can cause serious bodily injury.”

That still doesn’t explain why Tesla shouldn’t be allowed to operate its own stores, which by all accounts do a fine job with the minimal service an electric car re-quires, and can write finance contracts with the best of them.

“When I was at the FTC, we held a series of hearings on these laws,” Ellig recalled. “It was almost comical because we had separate panels on wine, autos, legal services, health care and telemedicine, charter schools. … All these panelists would come and testify and they hadn’t listened to the other panels, so the auto guys would say, this isn’t like wine and cheese, this is unique. The alcohol dis-

tributors said this isn’t like cars, and legal services said they were not like wine or cheese or books. Everyone was saying there was a unique reason that states should pro-tect their industry, and only their industry, from competition.”

* * *By this point, I expect most readers have

concluded that it is difficult to be optimistic that competitive market forces will triumph in these jealously guarded fortresses of economic privilege. Difficult, but hardly impossible. American economic history is full of examples of such privilege being eroded or broken, largely by changes in technology, the rise of countervailing business interests and/or growing public awareness of who foots the bill. Thus steel-consuming manufacturers man-aged to eliminate import protection for high-cost iron and steel makers, aided in no small part by the rise of domestic “mini-mills” that thrived without protection. By the same token, the rail and airline industries were unable to prevent economic deregulation once they lost control of their regulators and passengers tasted the fruits of competitive pricing.

Indeed, one can spot erosive forces at work in the three industries discussed here, as Tesla takes its complaints to a national stage, the funeral industry consolidates and an array of small wineries and craft beer producers take on the giant distributors. In healthy econo-mies, anyway, competition doesn’t stay dead for long.

The Milken Institute Review16

by jason furman

Inclusive GrowthFor once, some good news



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II expect the U.S. economy will complete its recovery from the Great Recession. But

even after it does, Americans will still face two related economic problems that

have been building for decades: the failures to generate sustained gains in income

for middle-class households and to combat falling living standards for many near

the bottom of the income distribution. While much of the developed world is

dogged by the same issues, my focus here is on what’s happened in the United

States – and, importantly, why we need not choose between economic growth

and ensuring that the benefits of growth are broadly shared.

the grim numbersA number of indicators offer a broad sense of living standards, but one that has the advan-tage of being available across a host of coun-tries and many decades is the average infla-tion-adjusted income for the bottom 90 percent of households. After rising strongly in most OECD economies in the postwar

years until about 1980, it has been roughly flat since then – though I should offer the im-portant caveat that income measures that in-clude employer contributions to health insur-ance and other benefits are, at least in the United States, still rising slowly.

In the case of the United States, and I sus-pect other countries as well, the path of aver-age incomes for the bottom 90 percent broadly tracks median household income. The story it tells is stark: even though GDP grew between 2001 and 2007, the typical family did not share in the gains – the first time an economic ex-pansion has not translated into rising middle-

note: Ireland data is based to 1943=100 and missing for 1944–1974. UK and Canada series have breaks in 1990 and 1982, respectively. Australia is indexed to 1951=100. source: World Top Incomes Database; CEA calculations

700

600

500

400

300

200

100

GROWTH IN REAL AVERAGE INCOME FOR THE BOTTOM 90 PERCENT

YEAR1990 2000 20101960 1970 19801950

Ireland

France

U.S.

U.K.Canada

Australia

IND

EX, 1

950=

100

(LO

G S

CALE

)

source: World Top Incomes Database; U.S. Census Bureau; CEA calculations

300

200

100

TWO MEASURES OF REAL INCOME GROWTH FOR THE UNITED STATES

YEAR1990 2000 20101960 1970 19801950

IND

EX, 1

950=

100

(LO

G S

CALE

)

Median Family Income (U.S. Census Bureau)

Average Income for Bottom 90% (World Top Incomes Database)


class incomes. Incomes subsequently fell in the Great Recession, implying that, over all, there has been no net increase in incomes for the less-than-affluent since the late 1990s.

The reasons for this sobering outcome vary from country to country, but two broad forces are generally at play. The first (which is less important in the United States) is productiv-ity growth. In the United States, total factor productivity (the total output generated by a given quantity of capital and labor) grew rap-idly after World War II as military innovations were commercialized. But it slowed drastically in the wake of the oil shock in the early 1970s. Productivity gains revived a bit – but only a bit – starting with the “new economy” in the mid-1990s. And this incomplete recovery explains in part the failure of the bottom 90 percent to make economic headway since the 1970s, es-pecially in the past two decades.

It is worth noting that slowing productiv-ity growth is a much more important part of the explanation for why income growth has lagged in continental Europe. Several of the large European economies enjoyed very rapid productivity increases in the decades after World War II, as they rebuilt their economies and moved closer to the technological fron-tier largely created by the United States. But this was catch-up, and thus temporary. As the effects of World War II receded and the tech-nology gap narrowed, many continental Eu-ropean economies saw their productivity growth slow. Moreover, they never experi-enced the modest rebound the United States did in the wake of the 1990s digital revolution.

In the United States (and other OECD countries to varying degrees), the primary source of the failure to generate sustained gains in middle-class incomes has been the fact that productivity growth has not trans-lated into commensurately higher middle-class incomes. The fissure is particularly stark

in the United States – but almost as troubling in Britain and France (see graphs on next page).

sources of the increase in u.s. inequalityTraditionally, research on inequality has fo-cused on inequality within labor income. Partly that is because labor compensation represents the bulk of all income, and changes

source: Bureau of Labor Statistics; CEA calculations

2.5%

2.0

1.5

1.0

0.5

0

GROWTH IN U.S. TOTAL FACTOR PRODUCTIVITY

YEAR1990 2000 20101960 1970 19801950

15-year centered moving average

1974-1995: 0.4 percent per year

1996-2012: 1.2 percent

per year

ANN

UAL

PER

CEN

TAG

E CH

ANG

E

source: Conference Board; CEA calculations

8%

7

6

5

4

3

2

1

0

15-YEAR CENTERED MOVING AVERAGE OF ANNUAL LABOR PRODUCTIVITY GROWTH

YEAR1990 2000 20101960 1970 19801950

PERC

ENT

PER

YEAR

Germany

Ireland

Italy

France

U.S.


in its distribution have (with important cave-ats) been the largest driver of inequality. Partly it is because we have better theories about the workings of labor markets than of capital markets, and better data to test them.

But this is changing. One of the vital con-

tributions of Capital in the Twenty-First Cen-tury, the much-discussed new book by the French economist Thomas Piketty, is to high-light the reality that the pace of investment and the returns to capital also play an impor-tant role in determining trends in income in-equality.

Decomposing the Increase in Inequality

Following Piketty, it is illuminating to decom-pose the sources of inequality into:

• Inequality within labor income

• Inequality within capital income

• The division of income between labor and capital

Each has different causes, dynamics and policy implications. Piketty does not measure their relative contribution to changes in in-equality in the countries he studies. But I’ve attempted to do the numbers here, quantify-ing the changes in inequality in the United States using data from multiple sources: Pik-etty and his co-researcher Emmanuel Saez, the Congressional Budget Office, and the U.S. National Income and Product Accounts (esti-mated by the Department of Commerce). Un-fortunately, a variety of technical issues make

source: Piketty & Saez; CEA calculations

300

250

200

150

100

50

0

SHARE OF TOTAL, LABOR, CAPITAL INCOME ACCRUING TO TOP 1%

YEAR1990 2000 201019801970

IND

EX, 1

970=

100

Share of Labor Income

Share of Capital Income

Share of Total Income

source: World Top Incomes Database; U.S. Census Bureau; CEA calculations

800700600500400

300

200

100

75

PRODUCTIVITY GROWTH AND AVERAGE BOTTOM 90% INCOME GROWTH

YEAR1990 2000 20101960 1970 19801950 1990 2000 20101960 1970 19801950 1990 2000 20101960 1970 19801950

IND

EX, 1

950=

100

(LO

G S

CALE

)

Labor productivity

Real average earnings for bottom 90%

UNITED STATES UNITED KINGDOM FRANCE

JASON FU RMAN is the chairman of President Obama’s Council of Economic Advisers.

http://www.economist.com/blogs/economist-explains/2014/05/economist-explains

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2333543



this decomposition less than an exact science. But a few broad conclusions do stand out.

Start with the results using data derived from Piketty and Saez. The top 1 percent’s share of total income rose from 8 percent in 1970 to 17 percent in 2010. Throughout this period the top 1 percent’s share of labor in-come rose steadily, but its share of capital in-come began a sustained rise only around 1990. All told, 68 percent of the increase in in-come for the top 1 percent across the four de-cades follows from increased inequality within labor income and 32 percent from in-creased inequality within capital income. Shifts in the division of income between labor and capital had no impact.

But capital looks a lot more important when one focuses on either the extreme upper end of the income distribution, or on changes in inequality in the most recent decades. The table above shows the relative importance of the distribution of income within labor in ex-plaining the increased share of income going to the top, with estimates based on different sources of data and different periods.

The higher up the income ladder you go, the less the overall increase in inequality is ex-plained by inequality within labor income

and the more it is explained by inequality within capital income. There is a strong tem-poral pattern as well, with inequality within capital income becoming increasingly impor-tant over time. The relevant CBO data go back only to 1979, and do not show any finer cuts than the top one percent. But they tell a similar story.

Inequality within Labor Income

Among the very top earners (the top 0.1 per-cent), about two-fifths of the income goes to managers in non-financial industries, about one-fifth to financial professionals, and the remaining two-fifths is spread across other occupations – notably, law, medicine, real es-tate, private business ownership, arts, media and sports. Explanations put forward for this phenomenon include:

• The increased return to skills, in large part due to a combination of the increased reach of corporations, entertainment and sports in global markets

• The slowdown in gains in educational attainment

• Changes in corporate cultures that have facilitated disproportionate increases in the compensation of senior managers

These factors, along with institutional

The higher up the income ladder you go, the less

the overall increase in

inequality is explained

by inequality within

labor income and the

more it is explained

by inequality within

capital income.

INCREASE IN INCOME SHARE ACCOUNTED FOR BY INEQUALITY WITHIN LABOR INCOME

TOP TOP TOP TOP 10% 1% 0.1% 0.01%

Income Including Capital Gains

1970-2010 (Piketty-Saez) . . . . . . . 83% . . . . . . . .68% . . . . . . . . 53% . . . . . . . . 39%

1980-2010 (Piketty-Saez) . . . . . . . 71% . . . . . . . .54% . . . . . . . . 59% . . . . . . . . 35%

1990-2010 (Piketty-Saez) . . . . . . . 64% . . . . . . . .51% . . . . . . . . 53% . . . . . . . . 37%

1980-2010* (CBO) . . . . . . . . . . . . . . . . . 70% . . . . . . . .42%

1990-2010* (CBO) . . . . . . . . . . . . . . . . . 64% . . . . . . . .31%

note: Values for any given year calculated as a centered three-year moving average.

*CBO estimates for 2010 are of that year alone


changes, including the decline in unioniza-tion, are also important in explaining changes in the middle of the earnings distribution. The decline in the real (that is, inflation-ad-justed) value of the minimum wage has had a particularly large impact on the bottom of the distribution.

Inequality within Capital Income

The second source of increased inequality can be attributed to changes in the distribution of capital income. In part, this is linked to the secondary impact of overall income inequal-ity: Very affluent people save more, which feeds inequality in wealth. But it also follows from the facts that wealthier investors tend to receive higher returns on their investments, and that tax rates on capital income have been cut in recent decades.

The forces driving inequality within capital income have been studied much less than labor- income inequality. But the subject clearly mer-its more attention in light of its increasing im-portance. Indeed, rising capital-income inequality explains a majority of the increase in inequality for the very top of the income distribution over the past 40 years, and is an even more important factor in the past 20 years.

Piketty points to the relationship between the returns to wealth and a nation’s economic growth rate as the crucial determinant for changes in inequality. In Europe, total wealth was seven times annual income in 1870. But wealth destruction in two catastrophic wars in the first half of the 20th century cut this to about two and a half times annual income in 1950, with only a partial recovery since.

In the United States (which lost far less wealth to war in that period and averaged faster economic growth), the ratio of wealth to annual income has held steady at about four to one for the last 140 years. The crux of Piketty’s argument is that the higher growth rate in the United States has resulted in a so-ciety with a higher income level relative to the accumulated wealth from the past.

The Division of Income between Capital and Labor

Wealth, and the income derived from wealth, is much more unequally distributed than labor

source: Piketty (2014); CEA calculations

800%

700

600

500

400

300

200

100

0

TOTAL CAPITAL IN THE UNITED STATES AND EUROPE

YEAR1950 201019101870

PERC

ENT

OF

NAT

ION

AL IN

COM

E Europe

United States

1890 1930 1970 1990

source: World Top Incomes Database; Economic Policy Institute

50%

40

30

20

10

0

U.S. UNION MEMBERSHIP AND TOP 10% INCOME SHARE

YEAR55 85 2005351915

PERC

ENT

Top 10% income share

Union membership rate

25 45 65 75 95


income. Thus, all else equal, when labor’s share of income falls, income inequality rises. In Europe, the share of income going to labor has been falling since about 1970, roughly the inverse of the overall rise in wealth (as one would expect). In contrast, in the United States, a marked decline in labor’s share oc-curred only after 2000.

The relative importance of this factor in the overall increase in inequality is harder to quantify because the data from Piketty-Saez and the CBO do not show a declining labor share of income after 2000, in part because of technical issues in distinguishing capital in-come from labor income for the most affluent. Using a different data set, one used to produce the official U.S. GDP statistics, the shift from labor income to capital income is responsible for roughly one-fifth of the overall increase in inequality since 1970. These data partly con-tradict the Piketty-Saez and CBO data, so the truth could lie somewhere in between.

the outlook for inequalityThe most striking argument in Piketty’s book is that a slowing of growth will inevitably lead to a sustained increase in inequality. He ar-gues that the distribution of wealth is a func-tion of the after-tax rate of return on capital minus the growth rate of GDP, or r – g. It is in-tuitive that wealth grows along with the after-tax return on capital (r), while wages grow along with GDP growth (g). Piketty projects that g will decline over the next century be-cause of demographic factors, and possibly

other factors as well. If r does not fall by as much as g, Piketty argues that wealth will be-come proportionately more important than earned income in determining the degree of inequality, raising the share of income going to capital and thus raising overall inequality. Piketty further argues that the increased im-portance of wealth will also result in the in-creased importance of inherited wealth in driving inequality.

Viewing the dynamics of inequality through this simple lens is both intriguing and disturbing – though it is unclear how much insight it actually yields. Piketty predicts that capital’s share of total income will rise, push-ing in the direction of increased inequality. But capital’s share is only one determinant of

Rising capital-income inequality explains a majority

of the increase in inequality for the very top of the

income distribution over the past 40 years, and is an

even more important factor in the past 20 years.

source: Bureau of Labor Statistics; CEA calculations

68%

66

64

62

60

58

56

54

52

50

0

LABOR’S SHARE IN NON-FARM BUSINESS INCOME

YEAR1990 201019701950 1960 1980 2000

1947-2000 Average

2013: Q4


inequality. A more important factor to date has been changes in inequality among labor income earners. Yet, for reasons not clear, Piketty assumes no future changes. Labor in-come inequality, after all, is tied to a mix of difficult-to-predict factors ranging from tech-nological developments to trends in CEO compensation to changes in minimum wages.

Moreover, economic theory offers little in-sight into whether slower GDP growth would, in fact, result in a rise in r – g. In general, when the rate of GDP growth falls, the ratio of capital to income rises – which tends to drive down the rate of return on capital. Whether the return on capital falls more or less than the growth rate falls depends on the ease with which capital can be substituted for labor: The lower the substitutability, the more r will decline as capital is added. Unfortu-nately, the degree of this substitutability has not been estimated with much confidence.

The return on capital is also influenced by households’ willingness to save. And with people expecting to live longer in retirement, people are likely to adapt by saving more re-gardless of interest rates – further driving down the return on capital.

As a result, theory offers no certain answer whether r – g would increase or decrease as a result of slower GDP growth. In fact, many standard economic models implicitly assume that r would fall by more than g. If that is in-deed the case, slower growth would lead to a re-duction in r – g, and consequently push in the direction of less inequality rather than more.

It’s worth noting that, separate from Pik-etty’s argument about increases in capital’s

share of income, it is plausible that continu-ing increases in income inequality within capital income will occur simply as a result of the large increases in inequality within labor income that have already occurred. Those made rich by the inequality of labor income will probably amass significant wealth.

the relationship between inequality and growthThere are good reasons to believe that causality runs both ways between inequality and eco-nomic growth, and by tortuous routes. This makes it difficult to be confident about analy-ses of the links between the two, but it is still possible to draw some tentative conclusions.

The Effect of Inequality on Growth

There is voluminous research on the ways that specific policies change individuals’ and firms’ incentives – and, in the process, affect economic efficiency and income distribution. Among the most cited findings is the trade-off between equity and efficiency. Hence, the often repeated “leaky bucket” metaphor coined some 40 years ago by Arthur Okun in describing the allegedly inevitable waste in policies designed to promote equity:

The money must be carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich.

But the evidence is mixed, with research-ers concluding that some income-support policies can positively affect both equity and efficiency. Moreover, the policy mix itself has

Newer research has identified a number of mechanisms

by which greater equality could increase the level of

output or its growth rate.

http://www.aspeninstitute.org/sites/default/files/content/docs/OKUN_EQUALITY_AND_EFFICIENCY_(AS08).PDF


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changed toward measures less likely to gener-ate inefficiency. For example, in the United States, traditional welfare programs have been eclipsed by tax credits that are both ad-ministratively less costly and create less disin-centive to work. Meanwhile, welfare pro-grams themselves have been substantially overhauled to reduce disincentives to work.

Traditional macroeconomic theory has also led economists to conclude there is a trade-off between equality and growth. The point often emphasized: Since high-income households save more, greater inequality translates into more savings and investment, and in turn, more output.

But newer research has identified a num-ber of mechanisms by which greater equality could increase the level of output or its growth rate. The logic starts from the obser-vation that the impact of the quantity of cap-ital in determining output is dwarfed by the

quality of capital, along with technology and entrepreneurship. Moreover, pervasive mar-ket failures – in which prices do not reflect opportunity cost – mean that the efficiency of outcomes may depend on the distribution of income. In particular, this approach empha-sizes a number of channels by which inequal-ity could harm growth by:

• Reducing access to the education neces-sary for labor to reach its full potential

• Reducing entrepreneurship and willing-ness to take risk

• Undermining the trust needed for a decentralized market economy to function efficiently

• Generating political instability that in-creases business uncertainty

Until recently, the macroeconomic evi-dence was ambiguous; it would be fair to say that, at a minimum, it has ruled out large negative effects on growth from progressive


policies that reduced inequality. But the latest cross-country statistical analysis from Jona-than Ostry, Andrew Berg and Charalambos Tsangarides at the IMF using a better data set is more encouraging – although, like all re-sults from cross-country evidence, it should still be taken with a grain of salt.

The study finds that, other things equal, greater inequality has a negative impact on both the rate of growth and its sustainability. Moreover, progressive policies in themselves have no statistically significant impact on the rate of growth, with a small caveat that poli-cies redistributing income to households in the top 25 percent – presumably, via non-means-tested entitlements – could have a small negative effect on growth. It follows that, to the degree progressive policies reduce inequality, they spur growth.

To put these findings in context, I apply them to the recent U.S. experience. Since 2009, the United States has made three sets of permanent changes to its tax code:

• Many of the tax cuts for high-income households that were passed in 2001 and 2003 were allowed to expire in 2013.

• New taxes dedicated to Medicare (a 0.9 percent tax on earned income and a 3.8 per-cent tax on investment income) were placed on high-income households in 2013.

• Tax credits for lower-income households with children and for college students were expanded for 16 million households by an av-erage of $900. (These expansions expire after 2017, but President Obama has proposed to make them permanent.)

Taken together, these policies will reduce the Gini coefficient, a standard measure of in-equality, by 0.6 index points – the equivalent of a rollback of about half a decade of drift toward greater inequality.

Using the estimates from the IMF study,

these tax changes should add 0.06 percentage points to the annual growth rate. At first glance, this seems trivial. But after a decade, it would translate into about $500 extra per year for a typical family of four. And this is on top of the direct benefits of the tax cuts accruing to lower- and middle-income households. Moreover, these estimates do not include the impact of the Affordable Care Act, which would more than double these reductions in inequality by expanding subsidies to low- and middle-income households.

The Effect of Growth on Inequality

There has been much less attention to the forces that run in the opposite direction – that is, how growth affects inequality. There is em-pirical research on the impact of level of out-put on inequality. The “Kuznets curve,” graph-ing GDP against measures of inequality, is an inverted U, with inequality high at low levels of income and low at higher levels of income, though there is little evidence that the rela-tionship is causal.

Piketty’s framework, for its part, has the potential implication that growth could re-duce inequality, although he does not explic-itly spell out this point. Specifically, raising g relative to r would reduce inequality. Intui-tively, raising g increases the importance of wages relative to wealth. This implies that la-bor’s share increases, reducing inequality.

liberation from the big trade-offModern economics has long been in the thrall of Okun’s “big trade-off,” the view that virtually any interference with free market in-centives with the goal of reducing income in-equality – policies ranging from higher taxes on high-income earners to minimum wage increases to subsidized medical care for the poor – would exact a price in economic effi-ciency and, ultimately, growth. The insight is

i n c l u s i v e g r o w t h

http://www.imf.org/external/pubs/ft/sdn/2014/sdn1402.pdf

http://en.wikipedia.org/wiki/Kuznets_curve


certainly accurate in some cases. A big aster-isk belongs here, though – or, I should say, asterisks.

Okun implicitly assumed that markets would otherwise work with perfect efficiency. More to the point, he assumed that in a less-than-perfectly-efficient market economy, policy interventions increase inefficiency rather than to reduce it. But we know for a fact that some interventions are a win-win, reducing both inequality and inefficiency.

A good example is early childhood educa-tion, which is widely acknowledged to yield among the highest returns of any area of in-vestment, yet disproportionately benefits families at the low end of the income distri-bution. The fact that this low-hanging fruit is there for the picking implies some form of market failure. The two prime candidates:

• Some of the benefits of early education are external to recipients.

• Capital markets are less than perfectly ef-ficient because poor people can’t borrow the tuition for preschool against the prospect of a

big increase in the kids’ future earnings.By the same token, investments in higher

education through subsidies that accurately reflect the demand for specialized skills have the potential to increase the growth rate, even as they ensure that the benefits of growth are broadly shared.

Another example – one in which the United States is a model – are cash subsidies to the poor that are tied to work. The Earned Income Tax Credit provides a match of up to 45 cents for each $1 earned by lower-income workers. This creates an extra incentive to work and can be an efficiency (and GDP) enhancer.

Perhaps the more striking fact is that the IMF study suggests that, on balance, progres-sive programs, even if imperfect in many countries around the world, may have none-theless been growth-enhancing. It is even possible that greater awareness of the effi-ciency implications of policy change has led to policy design in many OECD countries in which progressive policies lead to more growth, rather than less.

100%

80

60

40

20

0

ENROLLMENT RATES AT AGE 4 IN EARLY CHILDHOOD AND PRIMARY EDUCATIONM

exico

Belgi

umUnit

ed Ki

ngdo

m

Franc

e

Nethe

rland

s

Denm

ark

Norway

Icelan

dIta

lyGer

man

y

Irelan

dLu

xem

bour

gSw

eden

Israe

lHun

gary

Japan

Austri

aEs

tonia

Slove

niaPo

rtuga

lCz

ech R

epub

licKo

rea

New Ze

aland

United

Stat

esCh

ileSlo

vak R

epub

licAus

tralia

Polan

dFin

land

Cana

daSw

itzer

land

Turke

y

Spain

note: Data for Canada as of 2010, all other countries as of 2011. source: OECD


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That said, it is still important to remember that the potential for a trade-off between effi-ciency and equity should not necessarily take a policy initiative off the table. Much depends on the terms of the trade-off – the relative size of the benefits and the costs. In the case of the minimum wage, for example, our reading of the evidence is that an increase would have little or no impact on employment, yet would provide a substantial income increase for 28 million workers. But even some who believe that the minimum wage has a small negative impact on employment would still support an increase because this impact is outweighed by the very large number of beneficiaries.

Integral to any effort to analyze the growth impact of policies aimed at raising the living standards of families left behind in the past four decades is the issue of how to pay for it. Indeed, part of ensuring that everyone shares in the benefits of growth is making certain

that the process of enhancing medium- and long-term fiscal sustainability does not move the economy in the opposite direction.

One element of this is making sure that deficit reduction be done in a balanced man-ner that includes more revenue from high-in-come earners. In this spirit, the coverage ex-pansions in the Affordable Care Act are partly paid for with taxes on the income of house-holds at the top.

Moreover, the administration’s proposals for additional revenue to sustain the budget are centered on limiting tax benefits for high-income households – specifically an across-the-board limitation on the value of tax ben-efits in areas like housing, health care and pensions to 28 cents on the dollar for high- income households, which is less than the up-to-39.6-cent value of the current deductions and exclusions. Note, too, that reducing tax-based subsidies (as opposed to raising mar-


davi

d sm

ith

ginal tax rates) can be expected to reduce growth-inhibiting distortions in private mar-kets. In other words: another win-win.

Tax policy can also play a role in dealing with wealth inequality. This is not just true for taxes at the top, like the estate tax; what Piketty seems to underappreciate is that it is also true of what we can do to encourage wealth accumulation by moderate-income families. In recent years, a number of coun-tries, including Italy, New Zealand, Britain and the United States, have started to take ad-vantage of the fact taught to us by behavioral economics that automatic enrollment in re-

tirement savings plans and other sensible de-fault options can increase retirement security and wealth creation.

One final thought. It is time – long past time – to reject the conventional wisdom that greater inequality is the inevitable conse-quence of allowing technological change and global economic integration to power growth. There is just no compelling reason to believe that well-designed policies to narrow this widening gap would meaningfully reduce the level or growth of output, and every reason to believe they could provide a meaningful boost to working families.

And the guy on the spine is...Edmund (Ned) Phelps, the guy on the spine of the past four issues of the Review, who won a Nobel Prize in economics in 2006 for a giant — and rather depressing — insight. Before Phelps looked closely at the underlying theory, it was widely assumed there was a trade-off between inflation and unemployment: To buy a little less unemployment, you needed to pay with a little more inflation. But Phelps convincingly demonstrated that the trade-off wasn’t stable. If unemployment were pushed below the “natural” rate determined by factors specific to each economy, inflation would eventually begin to accelerate.

This bad news, incidentally, was interpreted by anti-Keynesians as a nail in the coffin of interventionist fiscal policy. But that’s way too strong a conclusion. The findings simply meant that fiscal stimulus (and, for that matter, monetary stimulus) has limits. And it shone a welcome light on the gritty problem of how to lower the natural rate of unemployment — how to make labor markets more efficient in matching supply and demand.

Like many other economics Nobelistas, Phelps has been tempted to pontificate about Big Ideas in the years following the award. But unlike most others, he’s really worth listening to — or reading. Check out his book, Mass Flourishing, an exceptionally smart analysis of modern economic history and what’s gone wrong with capitalism.

— Peter Passell

http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2006/popular-economicsciences2006.pdf

http://press.princeton.edu/titles/10058.html

http://press.princeton.edu/titles/10058.html


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What technology did the American public embrace

more rapidly than the telephone, radio, television,

personal computer or mobile phone? Genetically

engineered foods. More than a quarter of American

farmers snatched up seeds for genetically engineered

soybeans, corn and cotton (the source of cottonseed

oil) within three years of their commercialization. By

contrast, it took more than 13 years after the cellphone

was available for a quarter of Americans to own one,

and 26 years after the widespread availability of TV

for it to achieve that same feat. Last year, 90 percent

of corn and cotton acreage was planted with a geneti-

cally engineered variety; at 94 percent, soybeans man-

aged even greater market penetration.

It is a bit of a misnomer, of course, to say that the

American public embraced genetically engineered foods.

Most people didn’t know they were eating them. How-

ever, a flood of publicity (both hostile and celebratory)

is waking up consumers to the fact that much of the

food they buy contains ingredients that have been

genetically altered.

The term “genetically engineered” is a more ac-

curate descriptor than the more common monikers,

“genetically modified organism” or “GMO.”

by jayson lusk

In Defense ofFrankenfoods


tk


JAYSON LUSK is Regents professor and Willard Sparks endowed chair in the department of agricultural econom-ics at Oklahoma State University. He is author of The Food Police: A Well-Fed Manifesto About the Politics of Your Plate.

That’s because all living creatures’ genes have been modified over time though the pressure of natural selection – and in the case of vir-tually all plant foods, by human intervention to increase and stabilize yields and to raise quality.

The story of genetically engineered foods would be just one of myriad gee-whiz tales of technological change in agriculture were it not for the controversy this technology has sparked. A variety of concerns about potential health and environmental effects gained trac-tion in Europe when genetically engineered crops first came on the market in the mid-1990s. European regulators adopted a precau-tionary approach to those crops, failing to ap-prove many of them in a timely fashion despite a paucity of scientific evidence point-ing to health or environmental risks. And they mandated labels for foods made from GE crops, a deterrent to their use that is discussed in detail below.

Under threat of sanctions blessed by the World Trade Organization, the European Union has since approved many of the geneti-cally engineered crops that are grown in the United States. But the initial reluctance led to more public skepticism and less adoption than is the case on the other side of the Atlantic.

But that is not the end of the story, at least in the United States. Their consciousness raised by sensationalized documentaries and organized protests against Monsanto (one of the largest producers of seeds for GE crops), many American consumers have become alarmed to learn that they were eating geneti-cally engineered foods. The consequence:

some states are considering mandatory label-ing for such foods, and some local govern-ments have even banned cultivation of GE crops within their borders.

This is not any easy subject for consumers to master, and many have been swayed by sound bites. Indeed, scientists in favor of ge-netically engineered foods, as well as busi-nesses with a commercial stake in such foods, have made little headway in advancing their case amid the swirling claims about the tech-nology. That is more than merely unfortu-nate, because the stakes are so high. For GE crops hold out the best hope of sustaining the productivity growth in agriculture needed to feed the global population at reasonable cost without further polluting the planet. Here, I offer a short primer aimed at cutting through the confusion.

just the factsWe would scarcely recognize the ancient an-cestors of our modern agricultural commodi-ties. Ten thousand years ago, the plant we know today as corn was about the size of your thumb. Rice and wheat were little more than wild grasses sprouting fragile, barely edible seeds. Only by eating the seeds and replanting the ones that merited the effort did our ances-tors – first quite crudely, then more systemati-cally – modify the plants’ genes to produce the bountiful harvests we now enjoy.

There is a common view that we should only use those seed varieties and animal breeds that God (or the secular equivalent) gave us. Yet, nature is a moving target. And if one acknowledges man as a part of nature, it is difficult to categorize any of the developments in plant breeding as “unnatural.” None of this is to say that new scientific developments shouldn’t be subject to safety and environ-mental evaluations, as is now required of ge-netically engineered crops, only that the con-

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cept of naturalism has little bearing in the historical reality of food and agriculture.

It’s easy to take for granted the amount of change that has occurred. Looking just at re-cent history – say, from the early 1900s to today – corn yields have increased by around 500 percent. Some of the bounty is a result of better farming practices and increased avail-ability of inputs like nitrogen delivered with fertilizers. But much of it has resulted from improved genetics.

That 500 percent increase in yield means that today’s farmers could grow the same amount of corn as their great-grandfathers did on one-fifth the acreage or quintuple the output on the same acreage. Indeed, American farmers are now producing much more food than they were in the middle of the 20th cen-tury despite the fact that there is less land in production. Not only is this growth vital to keeping the food supply in synch with world population, but it is also sparing millions of en-vironmentally sensitive acres from cultivation.

Yield growth is increasingly dependent on

genetic engineering. Use of the commercially available varieties of genetically engineered corn, soybeans and cotton does not increase yields per se (and, in fact, can sometimes re-duce yields if the modifications are not intro-duced into hardy cultivars well suited for local conditions). Rather, these varieties pro-tect against insects and weeds that can reduce yields. Thus, the yield gains in part reflect the ability of GE crops to mitigate downside risks. Risk reduction is valuable to farmers, as are the other benefits that existing genetically en-gineered crops provide, including labor sav-ings, a reduced need to apply insecticides and the ability to use less-toxic and less-environ-mentally damaging herbicides.

While the advent of genetically engineered foods has no doubt benefited agribusiness gi-ants, including Monsanto, DuPont and Bayer, the fact that genetically engineered seeds have penetrated the market so rapidly implies that farmers think the higher prices for the seeds are worth it. Though it is less obvious, con-sumers have benefited too, since more stable


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yields lead to greater, less-volatile supplies and thus lower market prices for food.

The primary GE commodities now on the market in the United States have been engi-neered to survive applications of herbicides that kill weeds or to resist insects by giving plants the ability to produce chemicals that drive them away. Herbicide-resistant varieties of alfalfa, canola, corn, cotton, soybeans and sugar beets are in use. A variety of papaya that has been engineered to resist a virus that was devastating the industry in Hawaii is also in production. Many more plants with commer-cially useful traits are under development.

the scienceGenetic engineering involves the transfer of a gene (or multiple genes) from one species to another through synthetic means. Just be-cause the process occurs in a lab, it doesn’t follow that the resulting seeds couldn’t have been produced by “natural” means. Of course, some combinations – like the introduction of a fish gene into tomatoes, which was actually

done – would never have occurred naturally, and some beneficial natural combinations might never have been noticed.

Resistance to certain herbicides, for exam-ple, can also be attained, albeit at a slower rate, via traditional plant breeding. Indeed, many strains of rice grown today are conventionally bred to be resistant to herbicides. Traditional plant breeding requires the breeder to find wild or unusual cultivars that display the trait of interest and repeatedly crossbreed them with a commercial variety until getting an offspring that is similar to the original com-mercial variety yet exhibits the desired trait. Genetic engineering, by contrast, attempts to speed up the process by moving only those genes of interest into the commercial variety.

Sometimes these genes come from wild variants of the same species (using so-called cisgenic technology) or from entirely different species (using transgenic technology). As the comparison of cisgenic and transgenic tech-nologies suggest, the dividing line between what is and what is not genetically engineered is fuzzy and somewhat arbitrary: Transgenic is often considered genetic engineering, whereas cisgenic is not, despite the fact that both ap-proaches use the same methods and differ only in the origin of the genes transferred.

Some of the unusual cultivars used in aforementioned conventional crossbreeds are created by mutagenesis – that is, exposing seeds to radiation or to chemicals in hopes of random, beneficial, mutations. This approach has been used for more than half a century and is not considered genetic engineering, nor is it regulated as such. In fact, certified or-ganic seeds can arise from varieties produced via mutagenesis.

the debateFrom consumers’ perspective, the primary issue with genetically engineered food is its


safety. And here, there is near unanimity among scientists that eating such food has no impact on health. The most respected scien-tific authorities on the subject – among them, the U.S. National Academies of Science, the American Medical Association and the Ameri-can Association for the Advancement of Sci-ence – have concluded that currently approved genetically engineered foods are no riskier than foods bred through conventional means.

It’s true that there are a couple of studies, widely publicized by activists who oppose ge-netically engineered food, like one by Gilles-Eric Séralini, the crusader against genetically engineered food, purporting to show that rats fed genetically engineered corn develop tu-mors. In this (now retracted) research, how-ever, Séralini used a strain of rat known by re-searchers to develop tumors in advanced age even under normal conditions. Moreover, the study must be put in the context of a large body of scientific literature. There are literally hundreds of animal-feeding studies (not funded by the genetically engineered food in-dustry) showing no adverse effects from eat-ing genetically engineered foods. American consumers have been eating GE corn and soy for almost 20 years with no scientifically valid evidence of harm.

Critics of genetically engineered food point to rising autism and obesity rates, but these are purely illusionary correlations. Obe-sity rates were rising well before the advent of those GE foods, and rates of increase in obe-sity prevalence have slowed in recent years. This sort of naïve correlational thinking must also (absurdly) conclude that the rising num-ber of farmers’ markets has also contributed to obesity.

Ultimately, it must be recognized that ge-netically engineered foods are not a single

“thing.” To broadly claim that they cause harm lacks precision (not to mention evidence).

One needs to tie a specific genetic alteration to a specific type of harm. It is possible to imagine genetic modifications that could trig-ger allergies (the purely hypothetical example of inserting a peanut gene into corn comes to mind). But most of the commercially used ap-plications on the market today are not of this sort, and new GE crops that were couldn’t pass regulatory muster.

Certain varieties of genetically engineered corn convey insect resistance by producing the bacterium Bacillus thuringiensis, which kills many sort of insects, but is far less toxic to humans than many insecticides approved for agricultural use. In fact, that bacterium is an approved and widely used pesticide in or-ganic agriculture. The Food and Drug Ad-ministration requires that new genetically en-gineered crops meet standards of “substantial equivalence” – that is, they must be the same as the non-genetically engineered crop except for the trait of interest. And the new traits of interest are checked against a library of known allergens before approval is granted.

Whatever might be said about the advan-tages and disadvantages of the U.S. regulatory approval process for GE crops (which requires clearances from not only the FDA, but also the Agriculture Department and the Environ-mental Protection Agency), it is important to note that genetically engineered crops have been approved by many major governments all over the world, with different political and regulatory processes. The United States is the largest producer of GE crops in the world, but they are also extensively grown in Argentina, Brazil and Canada, and have been approved

http://en.wikipedia.org/wiki/S%C3%A9ralini_affair


and grown in smaller volume in Australia, Germany, Spain and the Czech Republic.

the great labeling fight Despite the fact that genetically engineered corn and soybeans have been widely grown since the mid-1990s, momentum to require mandatory labeling of GE foods in the United States did not gain much traction until quite recently. Although a mandatory-labeling bal-lot initiative failed in Oregon in 2003, Cali-fornia’s Proposition 37 reignited the issue in 2012. Early polling indicated that the measure would sail to victory, but a blitz of advertising by anti-Proposition 37 groups (mostly funded by large food and biotech companies), along with unfavorable editorials in major newspa-pers and opposition from scientific organiza-tions, stemmed the tide. Proposition 37 failed, though narrowly, receiving almost 49 percent of the vote. The following year, there was a similar ballot initiative in Washington State, which failed in another squeaker.

Those narrow defeats have encouraged la-beling advocates, who are backed financially by several large “natural” and organic food companies in addition to some consumer- advocacy groups. And they have had some suc-cess with state legislatures. Connecticut and Maine passed labeling laws in 2013 that will go into place if a threshold number of other states pass similar laws. This year, Vermont became the first state to pass a mandatory labeling law for genetically engineered food, and shortly thereafter two Oregon counties passed ballot measures banning the cultivation of geneti-cally engineered crops within their borders.

It is uncertain whether Vermont’s law will withstand challenges in federal court. Ten years ago, Vermont passed a similar, but nar-rower, law requiring labels on milk from cows that had been given a productivity-enhancing

bioengineered hormone called bovine so-matotrophin. The law was overturned in 1996, with a federal court concluding that the labeling requirement violated producers’ First Amendment speech rights since the FDA had found that milk from cows treated with the hormone was not substantively different from milk from untreated cows.

Polls conducted in Vermont while the la-beling law was in place are revealing. They showed only about half of consumers even noticed the change on the label, and of those who did notice, 79 percent interpreted the label incorrectly.

But legal and psychological uncertainties aside, mandatory labeling is increasingly looking like a winner in state legislatures. That explains why, in April, the food, farm and bio-tech lobbies have changed strategy, backing their own federal legislation – the Safe and Ac-curate Food Labeling Act (HR4432) – that would pre-empt state laws. The law, intro-duced by Kansas Republican Mike Pompeo, would reassert the authority of the FDA to de-termine both safety and the need for labeling. It would only require labeling if the FDA deemed there to be a “material difference” be-tween the bioengineered and conventional food that entailed a health or safety risk. The bill posits that the use of bioengineering, in it-self, does not constitute a material difference, and it would place proof requirements on food companies making claims that their products had no genetically engineered ingre-dients. It is unclear at this point whether the bill will get anywhere.

Labeling advocates often assert consumers’ right to know what is in their food. It is a bit unclear how far these rights should extend – is there also a right to know, for instance, which seed variety was used or the location of the farms that produced the crops – or whether such rights should be balanced against the


https://www.govtrack.us/congress/bills/113/hr4432

https://www.govtrack.us/congress/bills/113/hr4432


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costs of providing the information? However, the right-to-know argument has proved com-pelling for many, and it certainly makes for appealing sound bites.

Labeling proponents also argue that label-ing costs would be small (only the cost of ink), and point out that food companies routinely change packaging for other reasons. They are correct: The cost of adding a label would, in-deed, be trivial for most consumers if – and this is a big if – food companies choose to re-spond to the requirement by continuing their ingredient sourcing as usual and simply slap a “may contain genetically engineered ingre-dients” label on their products.

But food companies have argued that they will be eager to avoid the label (fearing con-sumer backlash and losing market share to competitors who eschew genetically engi-neered ingredients) and will switch to more ex-pensive non-genetically engineered ingredi-ents. If labeling policies create this sort of dy-namic, the costs for the average household could be substantial, and would be likely to dis-proportionately affect the poor, because they spend a higher share of their income on food.

At present, it is impossible to know whether the costs would be closer to the cost of ink or

to the several-hundred-dollars-annually fig-ure that has been tossed around by anti-label groups. Some who believe the latter point to the European example to predict what might be expected in the United States. European countries already mandate labeling, and food companies there have largely decided to avoid ingredients made from genetically engineered plants. As a result, it is difficult to find less-ex-pensive genetically engineered foods in most European countries. (The law, by the way, does not apply to meat from animals fed ge-netically engineered crops, and the European Union imports large amounts of GE soybeans from the United States for animal feed).

This would suggest that mandatory labels would substantially drive up costs and limit choice on this side of the Atlantic. However, the situation is less analogous than it might initially appear because Europeans had a pre-existing labeling law, and farmers and food companies simply chose not to adopt GE crops. By contrast, in the United Sates, genet-ically engineered crops are the rule rather than the exception, and dropping them could entail substantially more disruption. More-over, GE corn is likely to be grown regardless of the desires of food retailers, because more


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than 40 percent of the U.S. corn crop is cur-rently devoted to ethanol-fuel production.

The most substantive legal issue in the la-beling debate relates to the question of when, and under what conditions, the government can compel food companies to “speak” (that is, to add certain labels and disclosures). A le-gitimate argument could be made that such labels could be justified for ingredients that demonstrably affect human health, as is the case for, say, sugar, salt and fat content – all of which must be posted on nutritional-fact panels on food packages. However, the best scientific evidence available suggests no such safety or health risks from currently approved GE crops, and more generally, that the use of genetic engineering is a technological process, not a food-safety outcome.

One related concern with mandatory la-bels is that their mere presence might imply a safety risk, when, in fact, the evidence sug-gests there is none. This perspective was well articulated by Cass Sunstein, a University of Chicago law professor and President Obama’s

former regulatory czar, who is certainly not a political conservative. In a Bloomberg View column last year he wrote:

GM labels may well mislead and alarm con-sumers, especially (though not only) if the government requires them. Any such require-ment would inevitably lead many consumers to suspect that public officials, including scien-tists, believe that something is wrong with GM foods – and perhaps that they pose a health risk. Government typically requires labeling because it has identified such a risk (as in the case of tobacco) or in order to enable people to avoid or minimize costs (as in the case of fuel-economy labels). A compulsory GM label would encourage consumers to think that GM foods should be avoided.

the politics of genetically engineered foodsGiven the contentious nature of policies gov-erning GE food – and the growing plague of political partisanship – it isn’t surprising that the debate has taken on ideological dimen-sions. Many of the early protests over geneti-cally engineered food in the United States


originated with environmental groups that have historically been aligned with the left. The fact that today’s most popular GE crops were commercialized by large agribusiness and chemical companies has also tended to situate opposition to the technology among anti-corporate sentiments on the left.

While it is possible to be pro-biotechnology without being pro-Monsanto, such a nuanced position is difficult to maintain in the current atmosphere. It seems that many suffer from what might be called Monsanto Derangement Syndrome, buying into all sorts of conspiracy theories. Yet genetically engineered foods are no more synonymous with Monsanto than hamburgers are with McDonald’s. When anti-Monsanto became de facto anti-biotechnol-ogy, many left-leaning commentators chose to swim with the tide. Thus emerged a (justifi-able) belief that many on the left were anti-sci-ence on the issue of biotechnology. In the words of journalist Keith Kloor (writing for Slate), opponents of genetically engineered food “are the climate skeptics of the left.”

Although there is some truth to this obser-vation, the political reality is more complex. Indeed, it is possible to find strong sentiments against GE food expressed by some members of the far right. Often, this can be tied to pop-ulist attitudes, naturalistic-purity motives (sometimes religiously driven), or concerns about the viability of family farms in the age of genetic engineering.

An important distinction is the greater willingness of those on the left to regulate business than those on the right. Stated dif-ferently, there are questions of science: What are the risks of climate change or eating ge-netically engineered food? And then there are normative questions: Given that risk, what should be done about it? Even if the left and the right agreed on the level of risk, accord on the degree of government intervention

shouldn’t necessarily be expected. By analogy, thoughtful criticisms of climate-change poli-cies on the right aren’t criticism of the quality of the science, but rather skepticism about the ability of government to intervene fairly and effectively.

In surveys I led that were conducted in California leading up to the vote on Proposi-tion 37, liberals were much more likely to be in favor of mandatory labeling laws than were conservatives. However, other research has shown mixed results on the question of whether liberals or conservatives are more likely to think that eating genetically engi-neered food is unsafe. In a tracking survey I’ve run for the past 15 months that has re-corded more than 15,000 responses, consum-ers in the United States are asked to rate a se-ries of issues in response to the question,

“How concerned are you that the following pose a health hazard in the food that you eat in the next two weeks?”

One of the issues is “genetically engineered food.” The results reveal a slight tendency for conservatives to be less concerned about GE food than liberals (liberal respondents report, at most, an 8 percent higher level of concern than conservative respondents, holding con-stant other socio-economic characteristics). However, closer investigation reveals liberals are more concerned about all the food issues included on the survey (among them, salmo-nella and mad cow disease); concern about GE foods relative to all other food issues was no different among liberals and conservatives.

One paradox of sorts that has arisen from the desire for stricter regulation of genetically engineered crops is that large agrichemical companies would be handed a ticket to in-creased market power. Many universities and non-profits lack the resources and know-how to navigate the regulations required to de-velop and commercialize GE crops. To the

http://www.slate.com/articles/health_and_science/science/2012/09/are_gmo_foods_safe_opponents_are_skewing_the_science_to_scare_people_.html

http://jaysonlusk.com/blog/2013/5/22/the-food-demand-survey-foods


dismay of many, universities have entered into partnerships with seed and agrichemical companies precisely because of the difficul-ties associated with regulatory and commer-cialization costs.

It is tempting to believe that stricter bio-tech regulations hurt corporate interests, but such regulations often make it hard for non-incumbents to break down barriers to getting their innovations to market. Established agri-businesses that have teams of lawyers and lobbyists are often in a better position to ab-sorb the regulatory costs than smaller com-petitors. The goal shouldn’t be to keep large agribusinesses out of the seed and biotech market, but rather to make sure that the bar-riers to entry are low enough that anybody can compete with them.

the futureThe dramatic swings in support for labeling of GE food that were seen during the ballot initiatives in California and Washington re-veal that public opinion on the issue remains malleable. However, as the issue is increas-ingly discussed in the news, attitudes are likely to harden. Research shows that once people form opinions about a complicated issue, they often ignore evidence that con-flicts with their beliefs. So the next few years could prove critical in charting the future of genetically engineered food.

One promising sign: The elite media has begun to express more nuanced (and posi-tive) views about food biotechnology than was the case in the past. Even many critics have conceded that eating genetically engi-neered foods is safe and have shifted concerns to issues of market power, monoculture crop-ping and development of pesticide resistance, despite the fact that genetic modification is not intrinsically linked to any of these issues.

No doubt, some of the shift reflects a desire to gain some distance from the label of anti-sci-ence that has been (rightly) pinned on the anti-vaccine and climate-change-denial movements. But, it is also recognition of the potential benefits that biotechnology can provide to society, as well as to agribusiness.

My view is that the biggest costs of policies restricting or mandating labeling of geneti-cally engineered foods are not the likely im-pact on prices at the supermarket, but the possible creation of a climate hostile to agri-cultural innovation – a climate that retards technological change. Surveying the land-scape of genetically engineered crops cur-rently in development by university scientists, non-profits and biotech firms suggests just how much is at stake. A few examples:

• Staple crops grown in developing coun-tries are being engineered to produce micro-nutrients missing in the diets of some of the world’s poorest citizens. Golden rice and golden bananas, for example, are genetically engineered to produce beta-carotene, which can address vitamin A deficiencies that lead to hundreds of thousands of deaths and cases of blindness every year. Other examples in-clude high-iron beans and nutritionally en-hanced cassava and sweet potatoes.

• Insect resistance is being incorporated into staple crops in developing countries. For example, Bacillus thuringiensis cowpeas are being studied for use in western Africa. Built-in insect resistance would allow subsistence farmers who do not have access to traditional chemical pesticides to reduce volatility in yields.

• Nitrogen use can be reduced. For centu-ries, farmers have routinely applied nitrogen-rich fertilizers to increase crop production. Indeed, these fertilizers are critical to main-taining the sorts of crop yields we’ve come to depend on. But fertilizer runoffs compromise



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the quality of groundwater and threaten the environmental stability of streams and lakes. Some legumes, like soybeans, are able to grab nitrogen from the air, and thus have no need for nitrogen fertilizer. And scientists are at-tempting to engineer other staple crops, in-cluding corn, to do the same. Other research is focused on genetic modifications that im-prove the nitrogen and phosphorous utiliza-tion of crops, reducing the amount that farm-ers need to apply.

• There are other potential environmental benefits from genetic modification. Crops are being engineered to be more drought-tolerant and to make better use of scarce water sup-plies. Methane production by cows, which contributes to climate change, might be cut by feeding specially engineered grasses to the animals. Speaking of grasses, homeowners will soon be able to buy herbicide-resistant seeds for their lawns.

• Some genetic modification is focused on

making higher-quality products. The Flavr Savr tomato, which had a longer shelf life and thus could be allowed to ripen on the vine, was sold briefly in the mid-1990s before being withdrawn. Apple breeders are on the cusp of introducing the Arctic apple, which does not turn brown when it is cut up and exposed to air. High-oleic edible oils, which are low in saturated fat and have zero transfats, have been engineered to improve the shelf life and healthfulness of packaged foods.

Biotechnology is not the answer to all of the world’s food problems. And proponents of genetically engineered food have, at times, been guilty of overpromising. But given the confluence of tightening water supplies, cli-mate change, rising demand for meat in emerging-market countries like India and China, and a growing world population, ge-netic engineering will be necessary if we are to feed future generations at reasonable cost.

The biggest costs of policies restricting or mandating labeling of genetically engineered foods are the possible

creation of a climate hostile to agricultural innovation,

a climate that retards technological change.



AAfrica’s recent economic performance has

been widely celebrated in the media. Sub-

Saharan Africa’s inflation-adjusted growth

rate, after having spent much of the 1980s

and 1990s in negative territory, has averaged

nearly 3 percent annually in per capita terms

since 2000. This wasn’t as stellar as East Asia’s

and South Asia’s performances, but was decid-

edly better than what Latin America, under-

going its own renaissance of sorts, was able to

achieve. Moreover, the growth isn’t simply the

result of a revival in foreign investment: The

region has been experiencing positive produc-

tivity growth for the first time since the early

by dani rodrik

Why an African Growth Miracle Is Unlikely

http://www.economist.com/news/special-report/21572377-african-lives-have-already-greatly-improved-over-past-decade-says-oliver-august


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ious

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uter

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DAN I RODRI K is the Albert O. Hirschman professor of eco-nomics at the Institute for Advanced Study in Princeton, N.J. This article draws from Prof. Rodrik’s Richard H. Sabot lec-ture at the Center for Global Development in Washington.

1970s. It should not be entirely surprising, then, that the traditional pessimism about the continent’s economic prospects has been replaced by rosy scenarios focusing on Afri-can entrepreneurship, expanding Chinese in-vestment and a growing middle class.

But a reality check is in order here. As wel-come as this economic upturn has been, the the decline prior to the last decade was so deep that many African countries still have not caught up with post-independence levels of per capita income. If the World Bank’s fig-ures are to be believed, the Central African Republic, the Democratic Republic of Congo, Ivory Coast, Liberia, Niger, Senegal, Zambia and Zimbabwe are all poorer now than they were in 1960. Furthermore, the slowing of emerging-market growth elsewhere in the world and China’s troubles in rebalancing its own growth have led many to look more closely at the sustainability of the revival.

It’s clear that Africa has benefited from a particularly favorable external environment during the last two decades. Global commod-ity prices have been high and interest rates low. Private capital flows have supplemented in-creased official assistance from foreign donors and multilateral lenders. China’s rapid growth has fueled demand for the region’s natural re-sources and has stimulated direct investment in African economies. The global financial crisis, meanwhile, had little direct impact, given African countries’ weak financial links with the rest of the world and their limited de-pendence on formal capital markets.

Still, my prognosis for sub-Saharan Africa is on the pessimistic side, due to what I think

are poor prospects for structural change and industrialization. Perhaps Africa will prove the skeptics wrong. But if so, my guess is that it will be because these countries have devised an alternative to the engine that propelled rapid growth in Asia.

the economics of convergence Neoclassical growth theory establishes a pre-sumption that poor countries should grow faster than rich ones. After all, they have the ironic advantage of economic backwardness: low capital-labor ratios, which should raise the rate of return to investment, everything else being the same. Further, they have access to foreign capital to supplement domestic sav-ing, so the latter should not act as a constraint on the pace of investment. Finally, they are part of the global trading economy, so they can expand output more rapidly than domes-tic demand in goods in which they have a comparative advantage.

That said, convergence has, in fact, been the exception rather than the rule since the great divergence spawned by the Industrial Revolu-tion and the division of the world into a rich core and a poor margin. Except for the Euro-pean periphery and East Asia, sustained rapid growth in the lagging regions has been rare.

Growth theory has accommodated this empirical reality by distinguishing between unconditional and conditional convergence. Growth in developing nations is held back by a variety of country-specific obstacles. Ac-cordingly, developing nations’ convergence to rich-country income levels is conditional on these disadvantages being overcome.

The factors that determine long-run in-come levels are growth theory’s fundamentals. These include levels of investment, human capital and the impact of public policy on in-centives for work, innovation, savings and the like. They might be all viewed as being ulti-

a f r i c a n g r o w t h


mately determined by a country’s quality of in-stitutions (as has been argued forcefully by MIT’s Daron Acemoglu and Harvard’s James Robinson in Why Nations Fail). Or they may be determined by geography and ecology (as has been argued by Columbia’s Jeffrey Sachs). The quality of institutions themselves may be tied to initial levels of the human capital brought in by colonizers (as has been argued by Harvard’s Edward Glaeser and Andrei Shleifer). For the purposes of the present discussion, I do not need to take a strong stand among these con-tending perspectives on the true growth fun-damentals. As long as we leave room for human capital and institutions, I am happy to accept the argument that geography matters.

African countries cannot do much about their geography, but there is little doubt that their growth fundamentals on all other dimen-sions have improved significantly. Agricul-tural markets have been liberalized, domestic markets have been opened to international trade, state-owned or controlled enterprises have been disciplined by market forces or closed down, macroeconomic stability has been established and exchange-rate manage-ment is infinitely better than in the past. Polit-ical institutions have improved significantly as well, with democracy and electoral competi-tion becoming the norm rather than the excep-tion throughout the continent. Finally, some of the worst military conflicts have ended, re-ducing the number of civil war casualties in recent years to historic lows for the region.

That’s all good news, but how much growth should we expect from these positive changes? Improvement in the policy and institutional environment can be expected to generate greater economic stability and prevent deep crises arising from mismanagement. But it is not clear that these changes alone will serve as the engine for a growth miracle. My work and that of NYU’s William Easterly and others has

shown that the relationship between standard measures of good policy (such as trade liber-alization and low inflation) and economic growth is not particularly strong. A huge black-market premium for foreign currency and hyperinflation can drive an economy to ruin, but there is no significant, predictable difference in growth between an economy suffering inflation of 5 percent rather than 15

percent, or an average tariff rate of 10 percent rather than 25 percent. As economists, we have a pretty good idea of what can cause eco-nomic collapse, but not so much about what can produce a miracle. As a result, the upside potential of Africa’s progress on policy re-mains uncertain.

What about institutions, which have re-ceived so much attention in the development literature? Isn’t it the case that high quality in-stitutions make a huge difference to long-run income levels, and hence convergence pat-terns? Some studies (in particular, those by

10%

8

6

4

2

0

-2

GROWTH PERFORMANCE OF COUNTRY GROUPS SINCE 1980AVERAGE ANNUAL PER CAPITA GDP GROWTH

Latin

Amer

ica

& Carib

bean

(deve

loping

only)

Sub-

Saha

ran Afri

ca

(deve

loping

only)

East

Asia &

Pacifi

c

(deve

loping

only)

Midd

le Inc

ome

Low In

com

e

Sout

h Asia

Wor

ld

source: World Bank World Development Indicators

1980-19901990-20002000-2012

http://www.foreignaffairs.com/articles/138016/jeffrey-d-sachs/government-geography-and-growth

http://users.polisci.wisc.edu/straus/Straus%20Wars%20Do%20End%202012.pdf




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Acemoglu and Robinson and their colleagues) attribute the bulk of country variation in long-run income levels to differences in insti-tutional quality. But even if they are correct, this long-run relationship tells us rather less about growth prospects over the next decade or two. Empirically, the correlation between institutions (or the change in the quality thereof) and growth rates – as opposed to in-come levels – is not strong.

Few would deny that Latin America’s polit-ical and economic institutions improved sig-nificantly over the late 1980s and 1990s. Yet the growth payoff has been meager at best. Con-

versely, high-performing Asian economies such as South Korea (until the late 1990s) and China (presently) have been rife with institu-tional shortcomings, including cronyism and corruption, yet have done exceedingly well.

The empirical literature that finds the strongest results for institutions relies on concepts such as the rule of law or expropria-tion risk. An important problem here is that these are outcomes: They tell us something about investors’ evaluation of the economic environment, but not so much about how to get there. It remains unclear which policy le-vers have to be pulled to get those outcomes.

Bridge infrastructure, Ivory Coast into Liberia


As I have argued elsewhere, the function that good institutions fulfill (about which we have a fairly good idea) does not lead to unique forms (about which we know a lot less). That depends on local context and opportunities, and figuring it out can be quite hard. Thus, one lesson for Africa is that we should not be overly confident about the growth payoffs when countries adopt the formal trappings of

“good institutions.”

a structural transformation perspectiveSo standard growth theory, with its focus on long-run fundamentals, does not do a very good job in describing growth miracles. A complementary perspective is provided by the tradition of dual-economy models – models in which sub-economies operating at very different levels of development coexist in one economy – which have long been a staple of development economics. The birth of modern growth economics pushed aside this tradition, but it is clear that the heterogeneity in productive structures, which dual-econ-omy models capture, continues to have great relevance to low-income economies such as those in sub-Saharan Africa. Indeed, a hall-mark of developing countries is the wide dis-persion in productivity across economic ac-tivities – modern versus traditional, formal versus informal, traded versus non-traded, cash crops versus subsistence crops. And as recent research has shown, these divergences even exist within individual sectors.

What was explicit in those old dual-econ-omy models was the difference in the dy-namic properties of productivity across the modern-traditional divide. Traditional sec-tors were stagnant, while modern sectors ex-hibited returns to scale, generated technolog-ical spillovers and experienced rapid productivity growth. This picture has been

refined over time, and we no longer think of traditional sectors – such as agriculture – as necessarily stagnant. But in one important re-spect, recent findings reinforce the relevance of the dual-economy perspective. Modern, manufacturing industries are different: They do exhibit unconditional convergence, unlike the rest of the economy. Moreover, the esti-mated convergence rate is quite rapid, with a half-life of 40 to 50 years.

This is a rather remarkable result. It says that modern manufacturing industries con-verge to the global productivity frontier re-gardless of geographical disadvantages, lousy institutions or bad policies. Under better con-ditions, convergence is likely to be faster, of course. But what is striking is the presence of convergence in at least certain parts of the economy, even in the absence of good funda-mentals. This result is fairly general, regard-less of time period, region or level of aggrega-tion. In particular, the dozen or so African countries that produce data adequate to track change follow the same pattern as the rest of the world.

So can Africa generate a growth miracle based on the performance of manufacturing? The answer depends on the rate at which Af-rican economies can move their labor into modern manufacturing (and related) indus-tries. The dual-economy-augmented version

A TYPOLOGY OF GROWTH PROCESSES/OUTCOMES

INVESTMENT IN FUNDAMENTALS

(HUMAN CAPITAL, INSTITUTIONS)

SLOW

SLO

W

FAST

FAST

STRUCTURAL TRANSFORMATION, INDUSTRIALIZATION

No growth

Slow growth

Episodic growth

Rapid, sustained growth

http://www.hks.harvard.edu/fs/drodrik/Research%20papers/Unconditional%20convergence%20rev%205.pdf


of growth theory produces the following ty-pology of growth patterns.

As the diagram makes clear, long-term con-vergence requires both structural change and fundamentals. Rapid industrialization with-out the accumulation of fundamental capa-bilities (institutions, human capital) produces spurts of growth that eventually run out of steam. But in the absence of rapid structural change, investment in fundamentals on its own produces moderate growth at best.

the african contextSo where does Africa stand in structural change? Here, the picture is not bright. While farmers have moved out of rural areas and the share of agriculture in employment and value added has dropped significantly since the 1960s, the primary beneficiary has been urban services rather than manufactures. In fact, industrialization seems to have lost ground since the mid-1970s, and not much of a recovery appears to have taken place in re-cent decades. According to the best data we have at the moment, manufacturing’s share of employment stands well below 8 percent, and its share of GDP is around 10 percent, down from almost 15 percent in 1975. Most countries in Africa are too poor to be experi-encing deindustrialization, but that is pre-cisely what seems to be taking place in too many places! Compared to Asian countries, African countries at all levels of income re-main under-industrialized.

Moreover, few African countries are experi-encing the classic growth-promoting struc-tural change that East Asia underwent as part of the growth process. To take one recent ex-ample: In Vietnam, labor has moved rapidly from agriculture to more productive urban occupations. Manufacturing employment as a portion of total employment expanded by

eight percentage points from 1990 to 2008. But so has employment in many services, which are also more productive. This pattern of structural change accounts for around half of Vietnam’s impressive growth over the period.

The pattern in Africa, exemplified by Ethi-opia and Kenya, is more mixed. In each, there has been outmigration from agriculture, but the consequences have been less salutary. In Ethiopia, where there has been some growth-promoting structural change, its magnitude is much smaller than in Vietnam. Manufac-turing, in particular, has expanded much less. In Kenya, meanwhile, structural change has contributed little to growth. That’s because the large number of workers leaving agricul-ture have mainly been absorbed by services, where productivity is apparently not much higher than in traditional agriculture.

The even worse news for African manufac-turing is the degree to which it is dominated by small, informal (i.e., underground) firms that are not particularly productive. The share of formal employment in overall manu-facturing employment appears to run as low as 6 percent in Ethiopia and Senegal. And there is little reason to believe that informal firms are on the same escalator as modern firms with access to technology, markets and finance. Indeed, the evidence suggests that few small, informal firms ever grow out of in-formality. So informality is a drag on overall productivity. And that plays a large part in ex-plaining why not just services but also manu-facturing in Africa have been falling behind the productivity frontier, even in recent years with brisk growth.

high-growth scenariosTo generate sustained, rapid growth, Africa has essentially four options. The first is to re-vive manufacturing and put industrialization back on track, so as to replicate as much as

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es possible the now-traditional route to eco-nomic convergence. The second is to generate agriculture-led growth, based on diversifica-tion into non-traditional agricultural prod-ucts. The third is to kindle rapid growth in productivity in services, where most people

will end up working in any case. The fourth is growth based on natural resources, in which many African countries are amply endowed. Let me offer a few words about each.

What are the prospects for a renewed in-dustrialization drive in Africa? While the bulk

The even worse news for African manufacturing is the degree to which it is dominated by small, informal (i.e.,

underground) firms that are not particularly productive.

Freelance miners dig in an open-pit mine just outside the southern Democratic Republic of Congo copper town of Lubumbashi


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of Chinese investment has gone to natural re-sources, there have been some hopeful signs of greenfield investments in manufacturing as well in many countries of the region – no-tably, in Ethiopia, Ghana, Nigeria and Tanza-nia. Looking at some of these green shoots, one can perhaps convince oneself that Africa is well poised to take advantage of rising costs in Asia and turn itself into the world’s next manufacturing hub. Yet, as we have seen, the aggregate data do not yet show something

like this happening.There is almost universal consensus on

what holds manufacturing back in Africa. It is called “poor business climate,” a term that is sufficiently broad to offer room for virtually anything under its rubric. The list includes the high costs of power and transportation, corruption, inefficient regulation, poor secu-rity, contract enforcement and uncertainty about government policy.

If the problem is that such costs act as a tax on tradable industries, there is a relatively easy remedy that could compensate for them: the currency-exchange rate. A real exchange rate depreciation of, say, 20 percent, is effectively a 20 percent subsidy on all tradable industries. It is a way of undoing the costs imposed by the business environment in a relatively quick and easy manner. At the right exchange rate, many African manufacturers could compete with Chinese and Vietnamese exporters, both ex-ternally and in the home market. An under-valued real exchange rate may thus may be the most effective tool available for spurring in-dustrialization and hence growth.

Of course, achieving and sustaining a com-petitive undervalued exchange rate requires an appropriate monetary and fiscal policy framework. In particular, it requires manag-ing or discouraging capital and aid inflows and a tighter fiscal policy than would other-wise exist. These steps may not be easy, but may well be considerably easier to implement than the endless policy reforms needed to fix the myriad problems associated with the poor business climate. And once the economy is on a higher growth path, it may become easier to deal with those business-climate problems, thereby reducing reliance on the exchange rate.

On the other hand, the obstacles to indus-trialization in Africa may be deeper, and go beyond specific African circumstances. For


various reasons we do not fully understand, industrialization has become really hard for all countries of the world. The advanced countries are, of course, deindustrializing, which is not a big surprise and can be ascribed to both import competition and a shift in de-mand to services. But middle-income coun-tries in Latin America are doing the same. And industrialization in low-income coun-tries is running out of steam considerably ear-lier than was the case before. This is the phe-nomenon that I have called premature deindustrialization.

The first wave of industrializers, notably Britain and Germany, put more than 30 per-cent of their labor force in manufacturing be-fore they began to deindustrialize. Among Asian exporters, the most successful, such as Korea, reached a peak well below 30 percent. Today, countries such as India, along with many Latin American countries, are deindus-trializing from peaks that do not exceed the mid-teens. Even Vietnam, which is one of the most successful recent industrializers, shows signs of having peaked at 14 percent of em-ployment. Yet Vietnam is still a poor country, and in an earlier period would have had many more years of advancing industrialization.

The reasons for this common pattern of premature deindustrialization are probably a combination of global demand shifts, global competition and technological change. What-ever the reason, Africa finds itself in an envi-ronment where it is facing much stronger headwinds. Countries with a head start in manufacturing, having developed a large manufacturing base behind protective walls as occurred in both Europe and Asia, make it difficult for Africa to carve a space for itself – especially as global demand shifts from man-ufacturing to services. Having liberalized trade, African countries have to compete today with Asian and other exporters not

only on world markets but also in their do-mestic markets. Earlier industrializers were the product of not just export booms, but also a considerable amount of substitution of domestically made goods for imports. Africa is likely to find both processes very difficult, even under the best of circumstances.

What about the second scenario, agricul-ture-based growth? Since so much of Africa’s workforce is still in agriculture, does it not make sense to prioritize development of this sector? Without question there are many un-exploited opportunities in African agricul-ture, whether in perishable, non-traditional products such as fruits and vegetables or per-ishable cash crops such as coffee.

Yet, agricultural diversification seems to be hindered by many of the same obstacles as manufacturing – the term “poor business cli-mate” applies equally well here. In addition, agriculture has special problems that govern-ments need to fix, including poorly defined and enforced land rights, weak standard-set-ting, and uncertain input provision. That’s not to say the obstacles are insurmountable. Once again, the exchange rate could prove an im-portant compensatory tool. The main argu-ment against this scenario is that it is very dif-ficult to find examples of countries that have pulled off such a strategy. Agriculture-led growth implies that countries would sell their surplus on world markets, and that their ex-port baskets would remain heavily biased to-ward farm products. Yet one of the strongest

Since so much of Africa’s

workforce is still in

agriculture, does it not

make sense to prioritize

development of this sector?


correlates of economic development is export diversification away from agriculture. It is true that Asian countries, including China and Vietnam, have benefited greatly from early spurts in agricultural productivity – something that is particularly helpful for pov-erty reduction. But in all cases, the subse-quent and more durable boost came from the development of urban manufacturing.

Moreover, even if modern, non-traditional agriculture succeeds on a large scale in Africa, it would be unlikely to reverse the process of migration from the countryside. More capital and technology-intensive farming may even accelerate this process. So in one way or an-other, sub-Saharan African countries will need to develop an array of high-productivity sectors outside agriculture.

The third scenario for growth, gains in ser-vice-sector productivity, is one that perhaps raises the largest number of questions. When I lay out my pessimism on industrialization to audiences familiar with Africa, I invariably hear back a litany of success stories in services

– mobile telephony and mobile banking are the most common – that seemingly lead to a more optimistic prognosis.

With few exceptions, though, services have not acted as an escalator sector like manufac-

turing. The essential problem is that the ser-vices that play this role tend to require rela-tively high skills. The classic case is informa tion technology, which is a modern, tradable ser-vice. Long years of education and institution-building are required before farm workers can be transformed into software program-mers, or even call-center operators. Contrast this with manufacturing, where little more than manual dexterity is required to turn a farmer into a production worker in garments or shoes, raising his or her productivity by a factor of two or three.

So raising productivity in services has typ-ically required steady, broad-based accumula-tion of capabilities in human capital, institu-tions and governance. Unlike the case of manufacturing, technologies in most services seem less tradable and more context-specific (again with some exceptions such as cell-phones). And achieving significant produc-tivity gains seems to depend on complemen-tarities across different policy domains. For example, gains in a narrow segment of retail-ing can be accomplished relatively easily by letting foreign firms such as Walmart or Car-refour come in. But achieving productivity gains across the entire retail sector is ex-tremely difficult in view of the heterogeneity of organizational forms and the range of pre-requisites across product lines.

None of this is to say that the past must necessarily look like the future. Perhaps Africa will be the breeding ground for new technolo-gies that revolutionize services for broad masses, and do so in a way that creates high-wage jobs for all. But that is hardly a sure thing.

Finally, there’s natural-resource-based growth. Once again, the primary argument against this scenario is the paucity of relevant examples in history. Almost all of the coun-tries that have grown rapidly over a period of three decades or more have done so by indus-

Even if modern agriculture

succeeds on a large scale in

Africa, it is unlikely this

will reverse the process of

migration from the country-

side. More capital and tech-

nology-intensive farming may

even accelerate this process.


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trializing. In the post-World War II period, there were two such waves – one on the Euro-pean periphery (Spain, Portugal and Italy), the other in Asia (Korea, Taiwan and China). Very few countries have enjoyed rapid, sus-tained growth based on natural resources, and those that did were typically very small countries in unusual circumstances. Three of these countries were in sub-Saharan Africa: Botswana, Cape Verde and Equatorial Guinea. These cases demonstrate that it is, indeed, possible to grow rapidly if you are exception-ally rich in hard-rock minerals or fuels. But it would be a stretch of the imagination to think that these countries set a relevant example for countries such as Nigeria and Zambia, let alone Ethiopia and Kenya.

Moreover, the downsides of natural-re-source-based growth are well known. Re-source sectors tend to be highly capital-inten-sive and absorb little labor, creating enclaves within economies. Resource booms tend to crowd out other tradable goods, preventing industries with escalator properties from get-ting off the ground. Then, too, resource-rich economies experience substantial volatility in their international terms of trade as global commodity prices bounce around. And they have great difficulty in managing and sharing the windfall gains – the sometimes very large differences between extraction costs and world prices. Note, moreover, that institu-tional underdevelopment is often the price paid for resource riches. All these factors help

A bus driver navigates the congested streets of Freetown, Sierra Leone


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account for why resource-based growth has not paid off for most countries.

is a growth miracle possible?The balance of the evidence I’ve reviewed here suggests caution on the prospects for high growth in Africa. Much of the recent performance seems to be due to temporary boosts: an advantageous external context and making up of lost ground after a long period of economic decline. While the region’s fun-damentals have improved, the payoffs to macroeconomic stability and improved gov-ernance are mainly to foster resilience and to lay the groundwork for growth, rather than to ignite and sustain it. The traditional engines behind rapid growth and convergence – structural change and industrialization – are operating at less than full power.

So my baseline expectation would be moderate, steady growth, perhaps as high as 2 percent per capita annually, as long as the ex-

ternal environment does not deteriorate sig-nificantly and China manages its own sub-stantial macroeconomic challenges well. I hasten to point out that a growth rate of 2 percent on a sustained basis is not bad. In all likelihood, this would narrow the gap with the more-advanced economies, because the latter will not do very well in the decades ahead.

I can make one other prediction, one that I feel even more confident about. If African countries do achieve growth rates substan-tially higher than I have suggested is likely, they will do so by pursuing a growth model that is different from earlier miracles, which were based on industrialization. Perhaps it will be agriculture-led growth. Perhaps it will be services. But it will look quite different than scenarios we have seen before.

Institutional

underdevelopment is

often the price paid

for resource riches.


tk

The Social Safety Net

in the Great Recession

Success, failure, or a

little of each?by robert a.

moffitt


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ROBERT MOFFITT is the Krieger-Eisenhower professor of economics at Johns Hopkins University.

he Great Recession, which began in 2007, fully earned

that descriptive adjective. It was the deepest downturn in

postwar U.S. history, with GDP declining by over 3 percent

from 2007 to 2009, followed by an excruciatingly long recovery.

The unemployment rate rocketed from 4.4 percent in March 2007 to 10

percent in October 2009 and has dawdled downward ever since.

Indeed, the rate remained above 8 percent through the first half of 2012. Particularly disturbing was the increase in long-term un-employment – joblessness of more than six months – which rose from 20 percent of the unemployed in 2007 to 41 percent in 2012, and had barely inched below 35 percent by July 2014.

No surprise, then, that the role of the social safety net in protecting hard-hit families has been in the public eye. Most notably, both food stamps (now called the Supplemental Nutrition Assistance Program, or SNAP) and unemployment insurance, to name just two leading sources of assistance, expanded dra-matically. Food stamp spending more than doubled between 2007 and 2009, as the num-ber of people receiving benefits grew from 30 million to 50 million. Meanwhile, outlays for unemployment insurance quadrupled be-tween 2007 and 2009, reaching $128 billion annually. (Although unemployment insur-ance is not a means-tested antipoverty pro-gram per se, many low-income households benefit from it.)

But raw numbers don’t tell us all we need to know in order to judge the adequacy of the safety net or the merits of the programs that comprise it. How much of the increase in spending was automatic – that is, a straight-

forward consequence of layoffs and falling in-comes – and how much was due to the expan-sion of government programs? Which groups among those affected by the recession bene-fited the most, and which the least? How much went to the poorest of the poor rather than families still managing to scrape by? How much did these programs discourage work, thereby reducing the effective size of the workforce?

We now more or less know the answers. But before plunging in, it’s worth a look to see where the safety net stood just before the Great Recession began.

before the fallThe U.S. safety net is composed of dozens, if not hundreds, of programs, but just a handful of them drive total government spending and caseloads. The two classic welfare programs are Medicaid and food stamps, both of which require recipients to have very low incomes and meager assets to qualify. Of the two, Med-icaid is the elephant, with 2007 spending of $328 billion. Food stamp outlays totaled a

“mere” $41 billion. (Two other sizable pro-grams, it should be noted, subsidize school breakfasts and lunches for children from poor families.)

The traditional source of “welfare,” which used to be large but, by 2007, had shrunk to a shadow of its former self, is called Temporary Assistance to Needy Families. You may re-

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member its predecessor, Aid to Families with Dependent Children, which died with the Clinton-led reform in 1996. Temporary Assis-tance to Needy Families spending totaled only $11.6 billion in 2007.

Washington also underwrites housing as-sistance to low-income families. Plain-vanilla public housing is being phased out; many units have actually been demolished. But the gov-ernment does subsidize rents for families who find apartments in the private housing market, spending in total a shade less than $40 billion in 2007 – most of it on what is informally known as the Section 8 voucher program.

The last of the major welfare spending programs is Supplemental Security Income (SSI), which provided $41 billion in cash in 2007 to the elderly and disabled who were in-eligible for (or inadequately supported by) Social Security. Well, not quite the last. Al-though not usually viewed as welfare, the Earned Income Tax Credit provides refund-able tax credits – that is, cash payments in ex-

cess of other taxes owed – for working fami-lies with children. The maximum credit (as much as $4,000 annually) goes to families with earnings between $10,000 and $20,000. The Earned Income Tax Credit grew from modest origins in the 1970s to a major pro-gram today, mostly as the result of expan-sions of benefits and eligibility enacted under presidents George H.W. Bush and Bill Clin-ton. Total spending in 2007 topped $48 bil-lion, making it the fourth-largest program benefiting low-income families.

Finally, there are so-called social insurance programs that provide assistance to individu-als and families who have worked in the past and, directly or indirectly, paid premiums to the insurance funds. Unemployment insur-ance fits this category – as does Social Secu-rity Disability Insurance, which provides cash to those who have substantial work histories when they become disabled. Of course, the largest of the social insurance programs com-prise the Social Security retirement program


and Medicare, which provide a substantial portion of the income of the aging. Although none of these is targeted at low-income fami-lies per se, millions of poor families do, in fact, receive assistance from them. Moreover, the formulas that determine the amount of ben-efits effectively redistribute substantial sums from the general population to the poor.

the hammer fallsWhen unemployment rises, many safety-net programs kick in automatically. Thus as indi-viduals lose their jobs, those who’ve worked long enough to qualify receive unemploy-ment insurance benefits. And as household incomes fall, they become eligible for food stamps and Medicaid. Workers with depen-dent children who had been making $30,000-plus before being laid off and are able to find part-time work or lower-paying full-time work earning between $10,000 and $20,000 automatically receive Earned Income Tax Credit benefits as cash or as credits that re-

duce or wipe out paycheck deductions for So-cial Security and Medicare taxes. These and other automatic expenditures serve a dual purpose, keeping financially stressed house-holds above water and helping to stabilize the aggregate economy by injecting purchasing power.

But several important programs do not kick in automatically. Job loss does not di-rectly create disability, so neither Supplemen-tal Security Income nor Social Security Dis-ability Income outlays would necessarily rise. Moreover, an important feature of two safety-net programs – housing assistance and Tem-porary Assistance to Needy Families – limit the degree to which they can be expected to buffer falling incomes. They are not entitle-ment programs.

That is, families are not guaranteed help from them even if they fall below the income thresholds for eligibility. That’s because en-rollment is limited by the funds available. In-deed, there are long waiting lists for housing vouchers, and Temporary Assistance to Needy Families expenditures are limited by the size of the block grants Congress allocates to the states.

That said, Congress did raise spending on most assistance programs during the worst of the recession. In a series of bills in 2008 and 2009, it added weeks of eligibility to unem-ployment insurance, ending up with a maxi-mum of 99 weeks at the peak, compared to the 26 weeks normally available in good eco-nomic times. Moreover, between March 2009 and June 2010, Congress bumped up weekly unemployment benefits. Food stamp benefits were also temporarily raised, and additional funds provided for Temporary Assistance to Needy Families block grants to the states. The Earned Income Tax Credit, for its part, was in-creased for families with three or more chil-dren. One-time payments to Social Security

SOCIAL INSURANCE AND ANTI-POVERTY SPENDING BY PROGRAM, 1990-2010

source: The author

$300

250

200

150

100

50

0

YEAR98 2010941990

REAL

DO

LLAR

S PE

R CA

PITA

92 96 2000 02 04 06 08

EITC

AFDC/TANF

SSI

Housing Aid

Food Stamps

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retirees were added, too. Some additional housing assistance funds were provided.

a scorecardSpending on the 15 largest welfare, tax credit and social insurance programs rose from $1.7 trillion in 2007 to $2 trillion in 2009, a 17 per-cent increase. Excluding social insurance pro-grams – that is, focusing only on programs targeted specifically to low-income families – spending over the same period rose from $608 billion to $681 billion, a 12 percent increase.

But were these increases different in scale than in past recessions? The closest thing to the Great Recession that the economy has ex-perienced since World War II was the massive

1979–1982 recession, when Federal Reserve Chairman Paul Volker initiated a contraction-ary monetary policy to reduce the high infla-tion rates of the late 1970s. Unemployment rose from 5.8 percent in 1979 to 9.7 percent in 1982, only a slightly smaller increase than the one experienced from 2007 to 2009. Yet spend-ing on unemployment insurance grew by only half as much as during the Great Recession.

The growth in outlays for means-tested welfare programs was also much smaller under the Reagan administration. That’s in large part due to the fact that the Earned In-come Tax Credit had not been expanded and the food stamp program was still relatively small (though Aid to Families with Depen-


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dent Children was much larger than today’s Temporary Assistance to Needy Families pro-gram). All told, means-tested spending grew by only 6 percent in the early-1980s recession, compared to the aforementioned 12 percent jump during the Great Recession.

Why the bigger bang this last time around? No thanks to Temporary Assistance to Needy Families, which exhibited virtually no re-sponse to the latest downturn. In fact, a more detailed look shows that spending and case-loads actually fell in some states. Spending on Temporary Assistance to Needy Families block grants has been fixed in nominal dollars since 1996, and the special supplements pro-vided by Congress during the Great Recession were quite modest. In my view, the fact that there is no provision in the law to allow the TANF block grants to increase in a recession of the magnitude the country faced after 2007 signifies a major failure in public policy.

By contrast, the food stamp program (which is backed by farm lobbies as well as liberals) grew robustly. While some of the ex-pansion was simply the consequence of rising eligibility as household incomes fell, the growth stemmed from more than that. In the 2000s, the Department of Agriculture, realiz-ing that only about two-thirds of families for-mally eligible for food stamps were actually drawing benefits, encouraged state efforts to increase participation. Most states reduced the paperwork needed to prove eligibility, in-creased the length of time in which recipients would not have to resubmit evidence of eligi-bility, reduced the stringency of maximum-

asset tests and conducted media campaigns to recruit eligible households. These changes led to an increase in the food stamp program caseload and set the stage for rapid spending expansion when the Great Recession hit.

who benefited?The aggregate sum spent on safety-net pro-grams says a lot about their countercyclical macro impact, but not nearly as much about the degree to which they buffered the effect of the recession on individual households. Consider the Earned Income Tax Credit, which provides support mainly to those with an-nual earnings in the $10,000 to $20,000 range. An individual who has been laid off from his job and earns nothing or very little is not touched by the credit. It did help those who were earning above $20,000 prior to the re-cession and were pushed back into the $10,000 to $20,000 range. But these were not the poorest of the poor. Further, childless households benefit only marginally from the EITC because the credits go almost exclu-sively to those with dependents.

Temporary Assistance to Needy Families is another case in point. It is the only remaining program that provides cash assistance to fam-ilies with children, primarily single mothers, where the adults have no earnings. (TANF has work requirements, but still allows pay-ments to those searching for jobs.) Yet outlays from it were almost completely unresponsive to the recession because Congress chose not

Bureaucratic and marketing changes led to

an increase in the food stamp program case-

load and set the stage for rapid spending

expansion when the Great Recession hit.


to provide the funds. Note, too, that unem-ployment insurance provides assistance only to those with solid earnings histories over the previous year. Very low-income families with adults with spotty work histories – which is typical of low-skilled, last-hired, first-fired workers – are not eligible for unemployment insurance.

Nonetheless, the extra social safety-net spending was apparently spread widely. Data are available on spending for different groups from 2004 (rather than 2007) to 2010. But the earlier date serves as a reasonable proxy since unemployment was quite low. Families with the smallest amounts of earned income – those earning less than half of the poverty line

– on average received 23 percent more govern-ment assistance in 2010 than in 2004. Fami-lies with higher levels of earned income who were still poor had increases of 17 percent. Families with income just above the govern-ment poverty line had increases of 24 percent.

There were some differences by family structure, however. Low-income childless households received about the same increase in assistance whether they were very poor or had slightly higher private incomes (a 50–54 percent increase), as did married-couple fam-ilies with children. However, the very poorest single-mother households received a 25 per-

cent increase in aid from 2004 to 2010, com-pared to 54 percent for those with slightly higher incomes. The major reason for the dif-ference is, once again, the failure of TANF to respond to the recession. But those families did get significant additional support, mainly in the form of food stamps.

the downsideThe large increases in total safety-net spend-ing and the broad base of those helped should be viewed as an accomplishment be-fitting an affluent civil society. But the pro-grams that made the difference – food subsi-dies, Medicaid, social insurance and (in some cases) tax credits – share the flaw of discour-aging work because the gradual withdrawal of benefits as earned income rises acts much like an income tax. And, one might presume, the expansion of these programs to serve a broader swath of households presumably eroded work incentives further.

Happily, the impact of the disincentive is apparently modest. While the evidence un-questionably shows that work disincentives exist, they don’t merit the dark diagnosis of-fered by conservatives. Among the three pro-grams most responsible for the safety-net expansion in the Great Recession – unem-ployment insurance, food stamps and the EITC – the one with the strongest evidence of work disincentives is unemployment insur-ance. Increases in the amount of benefits typ-ically increase the length of time an individ-ual spends unemployed, as do increases in the length of the entitlement period. But esti-mates for the impact of the latter – the source of most of the higher impact of unemploy-ment insurance during this last recession – are relatively small, with most estimates showing that adding an extra week of unem-ployment insurance benefits lengthens the time spent unemployed by about half a day.

Outlays from TANF

were almost completely

unresponsive to the

recession because

Congress chose not to

provide the funds.

s o c i a l s a f e t y n e t

http://www.nber.org/digest/oct13/w19048.html

http://www.nber.org/digest/oct13/w19048.html


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Evidence for food stamps also suggests small effects: Studies typically show that the program reduces work by about an hour a week. This certainly meshes with common sense, since the average benefit is only about $5 per day per person, and can only be used to buy food.

The Earned Income Tax Credit is a differ-ent sort of animal, since it serves as a work disincentive for some and an incentive for others. Critically, it is a strong incentive to work for those earning $10,000 to $20,000 per year, with especially positive effects on em-

ployment for working single mothers.Indeed, the passage and expansion of the

Earned Income Tax Credit is strongly linked to a greater awareness among policymakers that traditional welfare benefits – more specif-ically, the formulas for their withdrawal – had a punishing impact on work incentives and served to trap some households in a cycle of poverty. Effective tax rates of 100 percent used to be common in welfare programs and, in some cases, effective rates remain confiscatory

– for example, for those with higher earnings who are facing the phase-out of benefits from

http://gspp.berkeley.edu/assets/uploads/research/pdf/1-s2.0-S0047272711001472-main.pdf

http://www.urban.org/UploadedPDF/412722-How-marginal-Tax-Rates-Affect-Families.pdf

http://www.urban.org/UploadedPDF/412722-How-marginal-Tax-Rates-Affect-Families.pdf


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several programs at the same time. But the EITC has changed that for many households with some earned income. With EITC sub-sidy rates up to 40 percent for those in the

“sweet spot” of the earned-income ladder, the net tax rates for poor working families are typically very low. For example, at 30 percent, the effective tax rate on food stamp benefits is in the same range as the Earned Income Tax Credit subsidy rate, so the net tax rate on earnings for a working family receiving both benefits is about zero.

One important caveat: Most of the evi-dence on safety-net incentives is based on studies of the programs during normal eco-

nomic times, not during major recessions. But while work disincentives could prove larger during recessions, they could be smaller as well. On the one hand, if jobs are very hard to find and require a great deal of effort to ac-quire, individuals receiving food stamps or unemployment insurance arguably may de-cide not to look for work in spite of the carrot of the tax credit. On the other hand, the lack of job opportunities means that even a great deal of extra looking may not result in much of an increase in work.

This implies that the effect of, say, an in-crease in the generosity of a welfare program may have smaller effects on employment dur-

There’s good reason to believe that future recessions will be no easier to manage because unemployment will

linger long after GDP recovers.

http://www.frbatlanta.org/pubs/annualreport/13ar/index.html#wheredoesthelabormarketstand_section


ing a recession than in normal times. Indeed, the only program for which incentive effects have been carefully studied during recessions is unemployment insurance. And here, the evidence suggests that the impact on labor supply is smaller, not larger, in hard times. Further, those who seem to stay unemployed longer because of the extensions of unem-ployment insurance benefits are mainly the long-term unemployed. And for a large frac-tion of these individuals, extensions merely postpone the day they drop out of the labor force altogether. Benefit eligibility thus isn’t likely to have much impact on the decision to work because the long-term unemployed simply don’t have much chance of finding jobs in the first place.

looking aheadMost of the safety-net expansions from the Great Recession have been phased out, and Congress apparently is in no mood to be gen-erous. The unemployment rate has fallen to a more palatable level (6.2 percent as this is being written), though the numbers are a bit misleading because many among the long-term unemployed have stopped looking and are thus no longer counted as part of the labor force. Going forward, public scrutiny is likely to focus on just two safety-net pro-grams: food stamps and the EITC.

The caseloads and expenditures in the for-mer have declined much more slowly than one would expect from a recovery at this stage. That’s probably because reforms of the 2000s, along with measures during the reces-sion that broadened eligibility, remain in place. And once households accept subsidies, they are often disinclined to stop doing so voluntarily. There is thus a legitimate concern that large numbers of recipients may stay on food stamps for extended periods.

As for the Earned Income Tax Credit, it is

more popular than ever, pleasing policy wonks drawn to its positive work incentives and finding a place in the hearts of conserva-tives because only those who work are eligible. There may even be broad support for increas-ing benefits going to childless households, who currently receive very little from the credit. There is also some recognition that the program’s formula discriminates unfairly against single-child families in favor of those with large broods.

Optimists can make a case that the safety net works – that tens of millions of Americans who suffered during the recession were buff-ered against the worst of it. Moreover, they can argue that the growing role of the EITC in both good times and bad reflects progress in finding a middle ground between allowing markets to decide who is poor and undermin-ing private incentives to escape poverty.

But there is also a case to be made that this glass is half empty. Washington has no plans for helping those permanently injured by this recession, the millions of long-term unem-ployed who are not likely to work again either because their skills are marginal or their résu-més have been tainted by years of joblessness. There’s good reason to believe, moreover, that future recessions will be no easier to manage because unemployment will linger long after GDP recovers. More generally, as the recession recedes, we will be left to deal with the chronic problems of high school dropouts and others with very low skills who are becoming road kill in the winner-take-all economy. And we will have to face the reality that many poor families must deal with barriers to work, in-cluding inadequate child care, poor health and, in most places, wretched mass transit.

Truth is, managing a safety net that mini-mizes costs and encourages work without al-lowing millions to slip through has never been easy. And it is not getting any easier.

http://www.frbatlanta.org/pubs/annualreport/13ar/index.html#wheredoesthelabormarketstand_section

tk

The Milken Institute Review66

TThe mention of Puerto Rico once

conjured visions of a tropical tax

paradise, complete with pristine

beaches and overproof rum. While

the beaches and rum remain, the

island’s increasing resemblance

to debt-ridden Detroit, fiscally

irresponsible Argentina, and

austerity-bludgeoned Greece is

enough to make all but the most

adventurous think twice about

investing there today.

by robert looney

Austerityin the

Tropics Is Puerto Rico the New Greece?


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ROBERT LOON EY teaches economics at the Naval Postgraduate School in California.

In four decades, Puerto Rico has gone from a model of development to a minefield for unwary bond buyers. Currently saddled with over $72 billion in debt, nearly four times the amount accumulated by Detroit, Puerto Rico’s annual debt service is close to $4.5 billion. The island’s population has shrunk to 3.7 million. Thus, interest alone on the public debt exceeds $1,200 per per-son, a serious burden for a place with barely one-third the median household income of the United States as a whole.

There are other ways to view this financial liability, but none of them makes for a pretty picture. Puerto Rico’s public debt equals over 70 percent of its GNP. By way of com-parison, profligate Argentina’s government debt is under 50 percent of GNP.

Not surprisingly, then, Puerto Rico’s bond debt was downgraded to junk status by all three major ratings agencies in February and downgraded further in July. Analysts are now debating the possible consequences for Wall Street, for tens of thousands of bond-holders and, of course, for Puerto Ricans. One thing on which all agree: Puerto Rico’s rocky footing is likely to get rockier.

if it walks and talks like greece…Until quite recently, Puerto Rico’s unique hybrid status as a U.S. territory provided more than adequate inducements to lure bond buyers. The island’s securities are tri-ple tax-exempt, so holders do not pay fed-eral, state or local taxes on their interest in-come. Government default is also prohibited

– at least in theory. These attractions, com-

Puerto Rico’s public debt

equals over 70 percent of

its GNP. By way of compari-

son, profligate Argentina’s

government debt is under

50 percent of GNP.

a u s t e r i t y i n t h e t r o p i c s


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bined with high ratings (before the fall) and a plentiful supply of securities, have prompted three-quarters of U.S. municipal bond funds to shovel in cash.

Puerto Rico’s unique status also contrib-uted to its indebtedness. The high demand for its tax-free municipal bonds has histori-cally kept the cost of borrowing low, lulling the government into reliance on long-term

debt to cover short-term spending. Its need to borrow, moreover, is exacerbated by the modest size of its tax base. Only Puerto Ri-cans employed by the U.S. government pay income tax on island earnings; others are ex-empt. To make matters much worse, Puerto Rico carries a number of large, unprofitable public corporations – notably, water and power utilities – on its balance sheets.


Puerto Rico’s economy stalled in the late 20th century, prompting the government to step up borrowing in the hope that it could spend its way out of the doldrums. But slow growth has only morphed to no growth, and the overextended government now faces the prospect of severe fiscal austerity similar to that imposed by the European Union on Greece. Like Greece, Puerto Rico’s lack of its own currency (and thus its own monetary and exchange-rate policies) severely limits what the government can do to manage the crisis. And just as many debated whether Greece would be better off if it left the euro zone, there is increasing debate over whether it would be in Puerto Rico’s interest to retain its current status as a territory, to demand statehood or to move toward greater inde-pendence in some sort of confederation with the rest of the United States.

boom and bust: 1940–2005 In the mid-1940s, Puerto Rico’s sugar-cane-based economy was one of the poorest in the Caribbean. Since then, its development pro-gram and economic relationship with the mainland have moved through several phases, each powered by financial incentives designed to make the territory attractive to investors.

In 1948, Washington introduced Opera-tion Bootstrap, a massive investment cam-paign aimed at rapidly industrializing the is-land. It seemed to work: Investment was accompanied by innovative economic and social programs that for a time won the island international praise as a development model.

With Operation Bootstrap, Puerto Rico’s ties to the United States were sweetened by advantages not available elsewhere in the Caribbean. Under the umbrella of U.S. law, Puerto Rico offered investors assurances of

contract and securities law enforcement un-matched in other parts of the developing world. What’s more, this was a period in which substantial tariff and quota barriers put the U.S. market off limits to other devel-oping countries. As a result, Puerto Rico en-joyed enviable advantages as an exporter.

The island economy grew impressively, presaging the awakening of the Asian Tigers – South Korea, Taiwan, Hong Kong and Sin-gapore. GDP increased by 68 percent in the 1950s and 90 percent in the 1960s (albeit from a fairly low base). By 1970, manufac-turing constituted a remarkable 40 percent of the island’s GDP, and joblessness had de-clined to 10 percent – astonishing progress from a traditional agricultural economy with high seasonal unemployment and widespread underemployment. For a time, it appeared that Puerto Rico’s per capita in-come might even converge with that of the United States.

Since then, however, growth has slowed drastically and income convergence has been reversed. The reasons are not difficult to discover. Unlike most U.S. states, Puerto Rico generated much of its electricity by burning oil. Thus, the 1973–1974 and 1979 oil shocks hit the island especially hard. At the same time, legislation that gradually ex-tended the federal minimum wage to Puerto Rico and increasing competition from Asia eroded both Puerto Rico’s production cost advantages and its attraction for corporate investors.

A new development phase began with ap-proval of Section 936 of the United States Internal Revenue Code in 1976. Under Sec-tion 936 (formally, 26 U.S. Code Section 936), subsidiaries of U.S. corporations oper-ating manufacturing facilities in Puerto Rico received federal tax credits that all but wiped out U.S. taxes on their Puerto Rican profits.


http://www.law.cornell.edu/uscode/text/26/936

http://www.law.cornell.edu/uscode/text/26/936


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The tax credits proved a powerful entice-ment for U.S. corporate investment in Puerto Rico, an era in which federal corpo-rate income taxes took a big bite out of their mainland earnings. Indeed, it signaled the beginning of an era of creative accounting in which companies would scheme to realize their profits in tax havens. The island’s man-ufacturing became more capital-intensive and diversified, marked by substantial in-vestment in pharmaceuticals, medical prod-ucts, scientific instruments, computers, mi-croprocessors and electrical goods.

But in 1996, Congress decided that Sec-tion 936, which encouraged capital-inten-sive investment, created too few jobs to jus-tify the cost in lost tax revenue and repealed

the law. The island’s industrialization pro-gram began a gradual decline that eventually became a free fall: The 10-year grace period on tax advantages for companies operating in Puerto Rico at the time of repeal ended in December 2005.

run-up to the crisisThe phaseout of Section 936 revealed the downside of Puerto Rico’s territorial status: When decisions critical to the territory’s prosperity are made in Washington, U.S. concerns come first and Puerto Rico’s second. Moreover, the creation of Nafta in 1995 al-lowed Mexico nearly equal U.S. market treat-ment – treatment that the subsequent estab-lishment of Cafta-DR extended to include


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Central America and the Dominican Repub-lic. For the first time since the 1940s, the is-land’s special status gave it no significant competitive advantage over other countries in the Americas that were operating at simi-lar levels of economic development.

Worse was yet to come. The 2008–2009 international financial crisis and the subse-quent slowing of the U.S. economy plunged the island into depression. Since 2006, Puerto Rico’s real GNP is down by 12 percent, with no recovery in sight. The island’s investment rate, which was around 30 percent of GDP in 2001, fell to 13 percent by 2010.

From 2006 to 2013, Puerto Rico lost 230,000 jobs in a workforce that numbered only 1.2 million. Federal transfer payments to Puerto Rican households – a mix of

safety-net payments ranging from unem-ployment insurance to food stamps to Social Security Disability – increased from 6 per-cent of personal income in the early 1970s to 22 percent today. The portion of the popula-tion living in poverty is now almost three times higher in Puerto Rico than on the mainland (46 percent versus 16 percent), with children and the elderly particularly af-fected. Moreover, according to the Census Bureau, income inequality is higher in Puerto Rico than in any U.S. state.

With jobs scarce and emigration to the mainland unrestricted, it should be no sur-prise that Puerto Ricans have been leaving the island in droves. According to the Census, about 75,000 Puerto Ricans migrated to the mainland in 2012, nearly 46,000 of whom

http://www.census.gov/prod/2011pubs/acsbr10-02.pdf

http://www.census.gov/prod/2011pubs/acsbr10-02.pdf


were younger than 35. The Puerto Rico Plan-ning Board estimates that by 2050, the terri-tory will lose another 1.3 million, more than a third of its current 3.7 million population.

stuck in the pastAlthough the onset of Puerto Rico’s current economic woes appears at first glance to co-incide with the revocation of the Section 936 tax incentives, the island actually began to lose its economic edge in the 1970s. Puerto Rico failed to adapt to globalization and changes in the world economy by switching to cheaper fuels to make electricity, by keep-ing wages low enough to compete with East Asian economies and by moving toward a more flexible industrial model. As a result, the island experienced a prolonged period of lethargic growth and ballooning government deficits, as every administration after 2001 issued additional debt rather than tightening its belt. Between 2008 and 2013 alone, Puerto Rico’s debt increased by 55 percent.

Given the deteriorating fiscal situation and the unlikelihood of a federal bailout, the current administration of Alejandro García Padilla does not have the luxury of its prede-cessors to kick the debt can down the road. And he knows it: In 2013, Padilla’s first year in office, the introduction of several new taxes to narrow the government’s deficit her-alded an era of austerity.

A cornerstone of the new taxes is the pat-ente nacional, an additional tax on gross busi-ness income known elsewhere as a gross re-ceipts tax. The patente nacional was expected

to raise roughly $500 million annually, more than one-third of projected new revenue for the 2014 fiscal year. It covers all businesses with gross revenue of at least $1 million, re-gardless of whether they are profitable.

The business community has raised an outcry, warning that the tax would force many firms into bankruptcy. Total island tax revenues from July 2013 through April 2014 were $442 million below expectations, sug-gesting that many businesses were, indeed, unable to raise the necessary cash.

As of late June, there was still uncertainty surrounding this fiscal year’s deficit and next fiscal year’s budget. Estimated projections for the 2014 deficit range from $365 million to $1 billion. For a time, the central govern-ment was without cash or credit, as were Puerto Rico’s largest public corporations – the Puerto Rico Electric Power Authority, the Puerto Rico Aqueduct and Sewer Au-thority and the Highways and Transporta-tion Authority – which together are respon-sible for almost 40 percent of the island’s public debt.

In March, Puerto Rico did manage to float $3.5 billion in general obligation bonds, enough to service its debts and cover the budget deficit through the 2015 fiscal year. To the surprise of many, and despite the re-cent junk status downgrades, the debt issue was vastly oversubscribed. Initial yields on long-term bonds were as low as 8.7 percent, compared with expectations of yields above 10 percent. Investors’ thirst for immediate in-come in an era of returns on U.S. Treasuries

From 2006 to 2013, Puerto Rico lost 230,000 jobs in a

workforce that numbered only 1.2 million. The portion

of the population living in poverty is now almost three

times higher in Puerto Rico than on the mainland.

http://www.mondaq.com/x/270752/tax+authorities/Puerto+Rico+Enacts+Technical+Amendments+To+Major+Tax

http://www.mondaq.com/x/270752/tax+authorities/Puerto+Rico+Enacts+Technical+Amendments+To+Major+Tax

http://www.foxnews.com/world/2014/03/11/puerto-rico-sells-35b-in-general-obligation-bonds-on-high-demand/


that hardly exceed the rate of inflation ap-parently worked in the island’s favor.

But the budget relief looks to be short-lived. A few months later, the Puerto Rico Planning Board projected a fall in GNP of 0.2 percent for the 2014 fiscal year and 0.7 per-cent for the 2015 fiscal year, with independent economists predicting a revenue contraction of 1.5 to 2 percent for 2015. The credit-rating agencies were obviously unimpressed in July 2014, when they downgraded Puerto Rico’s bond debt to even lower junk status.

Even optimists are having a hard time spy-ing a light at the end of the tunnel. The Eco-nomic Activity Index published by the Gov-ernment Development Bank showed that the economy contracted for the 19th consecutive month in April 2014, with the decrease felt across sectors. As of April 2014, Puerto Rico’s economy employed fewer than one million people, with the number of employed having decreased by about 25,000 since April 2013. At 14.1 percent, the unemployment rate was twice that of the mainland. Moreover, that figure doesn’t reflect the ballooning numbers of discouraged workers who don’t bother to register: The labor-force participation rate

fell below 40 percent for the first time ever.In late June, the government went into

full austerity mode with the passage of an emergency fiscal law allowing the adminis-tration to make spending cutbacks necessary to achieve a balanced budget. The measure will be in place for three years. An extension is possible unless three conditions are met:

• The previous fiscal year must end with a balanced budget.

• A Wall Street credit rating agency must peg Puerto Rico’s general obligation bonds at investment grade.

• The economic growth forecast must be at least 1.5 percent for the upcoming fiscal year.

The emergency measure was accompanied by the governor’s $9.6 billion spending plan for the 2015 fiscal year. The plan attempts to achieve more than $1.4 billion in cuts and ad-justments by consolidating 25 government agencies and, among other measures, closing around 100 public schools. Some $775 mil-lion is budgeted to amortize debt, $525 mil-lion more than in the 2014 fiscal year.

Classic fiscal austerity programs work only when the resources released through government cutbacks quickly translate into private spending to create jobs and private income. There is no indication that this will be the case in Puerto Rico.

Given the island’s long-stagnant economy, threadbare electric power system and large-scale emigration of its best and brightest, the most likely result is a vicious circle in which economic contraction accelerates and tax revenues shrink faster than government spending. Even fiscally conservative organi-zations like S&P, Moody’s Investors Service and Fitch, which for years have been advo-cating belt-tightening, have warned that Puerto Rico’s push for a balanced fiscal 2015 budget could further weaken its economy.

Recent research at the International Mon-

Even fiscally conservative

organizations, which for

years have been advocating

belt-tightening, have warned

that Puerto Rico’s push

for a balanced fiscal 2015

budget could further weaken

its economy.



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etary Fund has confirmed the shortcomings of similar austerity programs. Specifically, the fund warned that the impact of changes in government expenditures on GDP is gen-erally higher than previously estimated, im-plying that austerity policies can do more damage than generally believed. Indeed, a report by the IMF’s chief economist, Olivier Blanchard, concluded that the fund’s auster-ity policies in Greece had backfired, making a bad situation worse.

Perhaps in anticipation of potential prob-lems associated with austerity, the Puerto Rican government has introduced legisla-tion that lays a foundation for the restruc-turing of a portion of the debt owed by the country’s three major public corporations. The new law would create an orderly process in which to write off $22 billion of the $40 billion owed by the Puerto Rico Electric, Aq-ueduct and Sewer and Highways authorities.

Puerto Rico has been relatively lucky so far in terms of borrowing power, but the is-land seems to be drifting into uncharted wa-ters. Attempts at restructuring the public corporation debt could well lead to conta-gion to other bonds. Some investors already worry the new law signals that Puerto Rican officials are willing to change the rules to re-lieve financial stress, making the island’s general obligation bonds fair game for re-structuring, too.

As things now stand, Puerto Rico cannot declare bankruptcy, and the island’s consti-tution stipulates that debt payments on gen-eral obligation bonds receive priority over other spending. Should officials face a choice between honoring their bond obligations and firing large numbers of public employ-ees who provide basic services, however, the outcome is far from certain.

Further complicating the situation, a

http://www.imf.org/external/pubs/cat/longres.aspx?sk=40200.0

http://online.wsj.com/articles/puerto-rico-governor-proposes-law-to-restructure-public-entities-1403724012

http://online.wsj.com/articles/puerto-rico-governor-proposes-law-to-restructure-public-entities-1403724012


number of hedge funds purchased major tranches of the $3.5 billion general obliga-tion bonds issued in March. If the hedge funds choose to exploit Puerto Rico’s finan-cial desperation, they could further destabi-lize the investment situation by insisting on terms that guarantee them first-lien status in the event of a default.

Then there are the hopeless economics of Puerto Rico’s public corporations. While the corporations are supposed to be fiscally au-tonomous, they have been subsidized by the general fund for years and their employees are the best paid on the island. Since political pressure has made raising utility rates virtu-ally impossible, the government may be forced in the not-too-distant future to ac-knowledge that public enterprises are a losing proposition that can no longer be tolerated.

Hedge funds are betting on privatization, with some already buying the electricity au-thority’s bonds. The hope is that private op-erators could run the power plants more effi-ciently than the government and have some leeway to raise rates. Whether the Puerto Rican polity will cooperate remains to be seen.

pondering the futurePuerto Rico’s long-term economic prospects are complicated by uncertainty about the is-land’s status within the United States. Is the economy more likely to recover and prosper under its current territorial status, or with statehood, or with some sort of loose con-federation with the United States? While ad-vocates can be found for each, Puerto Ricans seem fairly evenly split between remaining a territory and becoming a state.

A recent General Accounting Office study suggested that Puerto Rico would probably receive a net benefit from statehood because it would be eligible for $9 billion to $10 bil-

lion in additional federal funding annually. But the GAO hedged its position by noting that “statehood’s aggregate fiscal impact would be influenced greatly by the terms of admission, strategies to promote economic development, and decisions regarding Puerto Rico’s government revenue structure.”

Puerto Rico’s governor, whose party sup-ports continued territorial status, argues the GAO’s calculations grossly underestimate the cost of statehood. According to García Padilla, if all residents were subject to federal taxes, the burden would turn Puerto Rico into a “Latin American ghetto.” In any event, it’s worth remembering that the choice of statehood is not entirely Puerto Rico’s to make: Congressional Republicans wouldn’t easily agree to give the heavily Democratic island two votes in the Senate and perhaps five in the House.

Puerto Rico’s economic model has tradi-tionally focused on keeping overhead and operating costs low to attract investment, en-couraging manufacturing and relying on abundant federal funding to fill the economic potholes. With the public utilities immobi-lized by debt and island businesses forced to pay wages unjustified by productivity gains, there is little hope that operating costs can be controlled. This alone makes it unlikely that U.S. offshore manufacturing will again play a dominant role in creating critically needed jobs. Moreover, given Washington’s shrink-ing budgets and the Puerto Rican govern-ment’s massive debt, there’s simply no chance that public spending will fill the gap left by the decline of manufacturing. Nor is it even remotely likely that the current austerity pro-gram will spur the sort of recovery needed to retain the island’s better talent.

There is, however, a modest source of hope. Some local governments are stepping in to manage the damage done by Puerto Ri-


http://www.bloomberg.com/news/2014-03-12/puerto-rico-lures-hedge-funds-for-record-junk-deal-muni-credit.html


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co’s failed economic model. The municipali-ties of Ponce, Barceloneta and Caguas are forging alliances with Puerto Rican business groups and mainland-based developers. Barceloneta, for example, has invested some $13 million in initiatives, including a tech-nological innovation center to train workers, and has fostered business incubators to ease the creation of new enter-prises. In rural areas, municipalities hope to pool resources in order to set up distribution hubs to deliver pro-duce to urban markets. As of mid-2014, around $1.5 billion had flowed into these sorts of local projects.

Moreover, the unique interplay between the tax code of the United States and that of Puerto Rico still gives the island some room to attract investment, as evidenced by two laws passed by Puerto Rico in 2012. To promote the export of services from the island and draw new profession-als, Law 20 reduced the corporate tax rate on service export revenue to just 4 percent. To encourage investors to immigrate to the island, Law 22 eliminates taxes on investment in-come (with the exception of divi-dends and interest from U.S. securi-ties, which are generally taxed by the federal government) once their Puerto Rican residence is established. As of April 2014, Law 22 had already at-tracted more than 200 wealthy investors in search of tax goodies.

With a lot of luck, Puerto Rico may be able to build on grassroots development ef-forts and the new tax incentives to dig its way out of a very deep hole. The success of this approach depends not only on attract-ing sufficient investment, but on developing and sustaining a strong local economic base

with market-driven policies and a business-friendly environment. Puerto Rico’s govern-ments, both central and local, will also need to make development their first priority, modernizing the island’s badly worn infra-structure and carefully targeting education to job creation.

Finally, given that markets, investors and prospective residents have all been spooked by political and economic uncertainty, it would probably make sense for Puerto Rico to make peace with its territorial status for the foreseeable future. Given the magnitude of Puerto Rico’s economic problems, allow-ing the interminable, contentious argument over political status to simmer is a lux-ury it can ill afford just now.


The Coming


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ac

Information and com-

munications technology has already revolutionized industries from publishing and

entertainment to education and health care – and now, it’s transportation’s turn. Two easy examples: Com-

muters can access real-time traffic information via their mo-bile phones, while adaptive signal lights can sense that a car is

waiting at a red light with no cross-traffic present and switch to green to accommodate it.

But perhaps the ul- timate manifestation of bringing intelligence to transportation is com-ing in the form of autonomous vehicles – cars and trucks that can literally drive themselves. Major car companies, including Audi, BMW, Ford, General Motors, Mer-

cedes-Benz, Nissan, Toyota and Volvo, as well as some formidable tech giants (notably Google) are vying to field AVs.

I believe the economic impact of autonomous vehi-cles will be huge, but not for the reasons widely

assumed. Direct productivity gains are likely to be modest since drivers still have

to be in cars, although

Re

volution

Tra

nsportation

by robert d. atkinson

The Coming


ROBERT ATKI NSON is president of the Washington-based Information Technology and Innovation Foundation.

now only as passengers. The bulk of the gains will come from reducing the costs associated with accidents and traffic congestion. A re-cent report from Morgan Stanley estimated that autonomous cars could save $1.3 trillion in the United States annually, with global sav-ings totaling more than $5.6 trillion. Cisco Internet Business Solutions Group forecasts savings of $810 to $1,400 per connected vehi-cle per year from reductions in crashes and congestion.

But for all their potential, autonomous ve-hicles aren’t just around the corner. Even the most optimistic predictions place the date of commercial availability five to ten years in the future. And skeptics, among them, John Leon-ard, the head of MIT’s Marine Robotics Group, told the New York Times “there won’t be taxis in Manhattan without drivers in my lifetime” because prices for many of the core technolo-gies underlying autonomous vehicles – com-puter processors, radar, cameras, side-laser scanners, ultrasonic sensors and global posi-tioning systems – just won’t come down to lev-els that are palatable to the mass market any time soon. Moreover, he and others point out that various companies’ prototype AVs still encounter difficulty in rain and snow.

This is why Lux Research predicts that a truly autonomous car with the versatility of an experienced driver will not be available be-fore 2030. Note, moreover, that since it takes at least 15 years to turn over most of the U.S. auto fleet, at best – assuming AVs become the standard in 2030 – we are talking about 2045 before they rule the road.

Sooner or later, though, AVs will almost certainly be ubiquitous. So it’s worth taking a closer look at the likely economic benefits

and the changes likely to be wrought by what promises to be a truly disruptive technology.

labor productivity MIT’s Andrew McAfee and Erik Brynjolfsson point to AVs as a proof for their thesis that technology is advancing so rapidly it will put people out of work faster than it creates jobs [see an excerpt of their book in the Summer 2014 issue of the Milken Institute Review – ed.]. But promises of higher productivity should be viewed skeptically. AVs are not Scotty’s Star Trek transporters; commuting in an AV will still require time en route. An AV would en-able people to do things other than drive – e-mail, reading, web surfing or catching up on Fast & Furious (Sequel 31). To the extent this activity involves “real” work, productivity will increase slightly.

If more significant labor-saving gains are to come from AVs, they will come from the auto-mation of trucking. The larger gains are more likely to be reaped in long-haul freight, where a truck is loaded at one warehouse and drives it-self hundreds or thousands of miles to another warehouse. Most local commercial trucking would still need a human to load the truck and make deliveries along the route. There are 1.6 million truck drivers in the United States, but many are not long-haul truckers. Equally to the point, trucking adds a relatively modest

ANNUAL ECONOMIC BENEFITS FROM SWITCHOVER TO AUTONOMOUS VEHICLES

u.s. economic economic benefits value-added

Productivity in Transportation Industry . . . . . . .$20 billionReduction in Accidents . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$900 billionReduction in Congestion . . . . . . . . . . . . . . . . . . . . . . . . . .$100 billionMore Efficient Fleet Utilization . . . . . . . . . . . . . . . . . .$12 billionReduction in Energy Use . . . . . . . . . . . . . . . . . . . . . . . . . . .$24 billionEstimated Total Savings . . . . . . . . . . . . . . . . . . . . . . . . . . .$1.05 trillion

source: Author’s calculations

t r a n s p o r t a t i o n

http://www.morganstanley.com/public/11152013.html

http://blogs.cisco.com/tag/connected-transportation/

http://www2.itif.org/2014-second-machine-age-review.pdf


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amount to GDP: If automation eliminated half of truck driver jobs, average labor produc-tivity for the economy as a whole would rise by about half a percentage point.

The story could be quite different for taxis. One could imagine an AV fleet, with individu-als hailing them with smartphone apps. These cars could even be owned by individuals who let them be used as taxis when they would oth-erwise be idle. But the numbers of jobs at stake

– and thus the potential for productivity gains – are not large in the greater scheme of things. Even if AVs freed all 240,000 taxi drivers for other work, the one-time productivity in-crease would be just 0.2 percent.

It’s possible that automated buses could be developed, but some degree of on-board su-pervision would still be needed. If half of bus driving jobs were eliminated, average economywide labor productivity would in-crease by just 0.1 percent. That doesn’t en-tirely exhaust the potential of commercial AVs. The mining company Rio Tinto is already de-

ploying self-driving ore trucks. But again, the numbers suggest evolutionary gains, with roughly $20 billion annually in labor saving.

improved safety More significant gains will probably come from collision avoidance. According to the Department of Transportation, the direct cost of traffic accidents in the United States totaled $277 billion in 2010, including $93 billion in lost productivity, $76 billion in property dam-age, $35 billion in medical expenses and $28 billion in added traffic congestion. Strikingly, this figure was dwarfed by an estimated $594 billion in indirect costs – decreased quality of life due to injuries and death. Human error causes a vast majority of traffic accidents. In fact, one federally funded study from the 1970s estimated that human error probably caused over 90 percent of these accidents. And while that study is dated, one would expect the figure to be even higher in an era in which vehicles are far better equipped for safety.

Autonomous vehicles could drastically re-duce accidents. Most obviously, AVs don’t drive while distracted, tired, inebriated or im-paired by age or inexperience. And, of course, they can be programmed to obey traffic laws. Less obviously, new technologies – including communication among AVs – will add a layer of protection unimaginable a few decades ago.

While it would be unreasonable to imagine a future in which an autonomous vehicle is never involved in an auto accident – among other issues, AVs will have to share the road with human drivers for a very long time – Google notes that its driverless cars have al-ready logged more than a half million miles without causing an accident. Moreover, even before truly autonomous vehicles roam the roads, a range of IT-enabled automated driver assistance technologies – including blind spot detection, lane departure warnings, dangerous

http://cyberlaw.stanford.edu/blog/2013/12/human-error-cause-vehicle-crashes


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proximity (precollision) indicators, rearview cameras and parking assistance – are already having a significant impact in reducing acci-dents and injuries.

For example, since 2010, Volvos equipped with a collision avoidance system that can au-tomatically brake to avoid obstacles have ex-perienced one-quarter fewer property-dam-age claims than Volvos without the system. According to the insurer-supported Insur-ance Institute for Highway Safety, forward collision warning systems lead to a 7 percent reduction in vehicle-to-vehicle collisions. That number increases to 15 percent with au-tomatic braking systems.

A recent study by engineers at Virginia Tech University examined some 2,500 colli-

sions resulting from unintended lane depar-tures from 2007 to 2011. They found that if the vehicles had been equipped with lane de-parture warning systems, 30 percent of the crashes could have been avoided. The science journalist Philip Ross notes that parallel sim-ulation examining the effects of forward col-lision warning systems “found far greater dif-ferences, preventing as many as 53 percent of rear-end collisions.”

infrastructure performanceA third source of savings will come from im-proved system performance – that is, in-creased road capacity and reduced conges-tion. In 2011, Americans lost 5.5 billion hours (and 2.9 billion gallons of fuel) waiting in

Because AVs need less headway to operate safely,

highways carrying only autonomous vehicles could

accommodate two to three times as many automobiles.

http://ieeexplore.ieee.org/xpl/login.jsp?tp=&arnumber=6728260&url=http%3A%2F%2Fieeexplore.ieee.org%2Fstamp%2Fstamp.jsp%3Ftp%3D%26arnumber%3D6728260

http://spectrum.ieee.org/cars-that-think/transportation/advanced-cars/how-many-lives-will-robocar-technologies-save


traffic, which translates into 38 hours per year for the average commuter. The Texas Trans-portation Institute’s Urban Mobility Report estimates that this “congestion penalty” – the value of commuters’ lost time and extra pay-ments at the pump – conservatively cost Americans over $400 per person in 2011.

One study estimated that even a highway running at peak capacity has only 4.5 percent of its surface area occupied. But because AVs need less headway to operate safely, highways carrying only autonomous vehicles could ac-commodate two to three times as many auto-mobiles. Moreover, because one-fourth of congestion is attributable to traffic incidents that would largely be avoidable, AVs would increase throughput this way as well. Note, too, that the more efficiently existing trans-portation infrastructure is utilized, the less need there will be to invest in new roadways. Assuming that AVs reduce congestion by half, the economywide savings could run to $100 billion per year.

AVs would also enable more efficient park-ing since they could drop off passengers, park themselves at considerable distance and re-turn when called. Note the synergies here: A substantial portion of urban congestion con-sists of inefficient searches for parking – much of which could be eliminated by auto-mated parking systems.

increased fleet utilizationAVs are well positioned to increase use of ve-hicles as well as road and parking infrastruc-ture. Today, the average American vehicle sits idle 95 percent of the time. But autonomous vehicles could be shared, much the way pri-vate aircraft are shared today, with computer systems routing and positioning vehicles for minimum wait time. They will also present a compelling mobility option for those who don’t wish to own vehicles. Instead of turning to taxis, Uber or Zipcar when one needs tem-porary transportation, one can imagine just hitting a button on a smartphone app and an

http://d2dtl5nnlpfr0r.cloudfront.net/tti.tamu.edu/documents/mobility-report-2012.pdf

http://www.nytimes.com/interactive/2012/06/03/magazine/innovations-issue.html?_r=1&


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autonomous vehicle that your neighbor owns shows up to take you to your destination.

A recent study calculated that a fleet of au-tonomous vehicles acting as a personalized public transportation system would be cheaper and more efficient than taxis, using half the fuel and a fifth the road space of or-dinary cars. Another study showed that a sin-gle shared AV could replace between 9 and 13 privately owned vehicles without impeding travel behavior.

Reducing the number of cars would not reduce costs proportionately because cars de-preciate from use as well as age. If increased car sharing allowed a reduction of just 15 per-cent of passenger vehicles in the fleet, I esti-mate the savings would exceed $70 billion per year. Assuming that the remaining cars are driven 15 percent more to make up the differ-

ence, the economic benefits (netting out faster fleet depreciation) would be approxi-mately $12 billion per year.

energy savingsWith all other things equal, AVs would also reduce energy consumption for travel. As noted earlier, less congestion means higher mileage.

But AVs would also be able to save by “pla-tooning,” in which a line of trucks would ride only a few feet apart in order to reduce wind resistance the way stock car drivers “draft” to conserve fuel. A Stanford University technol-ogy spinoff, Pelaton, estimates that in a two-truck platoon the rear truck could save ap-proximately 10 percent in fuel costs. If platooning increased average fleet mileage by 5 percent, the savings would come to $24 bil-lion annually.

t r a n s p o r t a t i o n

http://stanford.edu/~connorb/cgi-bin/Peloton/homepage.php


other economic benefitsJust some of the possibilities: With AVs, trav-elers will probably substitute driving for air-line travel in medium-distance trips because AVs would be faster than ordinary cars and would allow them to work or play en route… Driving classes and schools are likely to go the way of the manual transmission, once AVs dominate… Much safer roads would allow government to reduce traffic police… Roads would not need to be as well lighted since AV guidance would be electronic… Autonomous vehicles could significantly enhance personal

mobility and convenience, particularly for the elderly, disabled and, of course, children… Quantifying this last benefit would not be easy, but it does suggest just how disruptive AV technology could be to a society that is rapidly aging.

getting to the av futureFor all their promise, making the transition to AVs will pose challenges. The major one is cost. Innovation and scale economies can be expected to bring down these costs eventually, but for now they are a key barrier. Steven

Autonomous vehicles could significantly enhance personal

mobility and convenience, particularly for the elderly,

disabled and, of course, children...


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Dellenbeck of the Southwest Research Insti-tute in San Antonio estimates that the cost premium will not fall below $10,000 for at least a decade. On reflection, $10,000 isn’t a lot of money in light of the product’s advan-tages in safety and efficiency. But the public will have to be educated about AVs before they’re willing to switch; a JD Power survey in 2012 found that only 20 percent of consum-ers would buy an AV if the price premium was more than $3,000.

More to the point, the public will have to be convinced that driverless cars are very safe; the JD Power study also found that only 37

percent of consumers would definitely or probably buy an AV if it were available, re-gardless of the price. It is not all that surpris-ing that ceding control of vehicles to comput-ers is daunting to most people. But enthusiastic acceptance would be critical to market viability because much of the benefit to society depends on wide adoption.

To see why, consider the research of Ste-ven Shladover, an engineer at the University of California, and colleagues. They estimate that adaptive cruise control in which AVs communicate with one another could in-crease lane capacities by 80 percent if 90 per-

Enthusiastic acceptance would be critical to

market viability because much of the benefit to

society depends on wide adoption.

http://www.jdpower.com/sites/default/files/2012049-uset.pdf

http://trb.metapress.com/content/c7x847k3647888n1/


cent of cars had it. But if only 50 percent of vehicles have the technology, lane capacity grows by only 21 percent.

In other words, this is a classic case in which much of the benefit is “external” to the owner of the vehicle. In cases like this, the ec-onomically rationale way to correct what amounts to market failure is to tax the exter-nal costs and subsidize the external benefits. Hence, the logic of speeding the transition to AVs by subsidizing them, at least temporarily (as the federal government has done for paral-lel reasons with hybrid and electric vehicles).

Governments will also have to make AVs legal. Four U.S. states – California, Florida, Michigan and Nevada – along with the Dis-trict of Columbia have passed laws permit-ting open road testing of autonomous vehi-cles. Europe is also beginning to look at adjusting its laws with regard to legalization of AVs. But as a BMW representative recently noted, “The legislation is just not in place for us to be able to put these [autonomous] vehi-cles on the [European] market.”

Still, an important step toward this end was taken in April 2014 when an amendment to the Vienna Convention on Road Traffic (an international treaty designed to facilitate in-ternational road transit that covers 72 nations with the major exceptions of the United States, China and Japan) was adopted that will permit AV use on public roads, so long as the vehicle can “be overridden or switched off by the driver.”

Europe also has a potential advantage over the United States if it can make autonomous vehicles legal for sale and operation across the entire European Union, while in the United States the legal status of autonomous vehicles is determined on a state-by-state basis. In May 2013, the U.S. National Highway Trans-portation Safety Administration issued a pre-liminary policy statement intended to guide

states in permitting testing of the emerging vehicle technology. But NHTSA can only ad-vise the states, which will make their own de-cisions. Arguably, the best reason for opti-mism here is that states will be competing to attract AV manufacturers, which will presum-ably be leery of jurisdictions that are unwill-ing to give them leeway in use on the roads.

A particularly thorny issue will pertain to legal liability – specifically, who is liable if an autonomous vehicle is involved in an acci-dent. Is it the passenger (who is no longer the driver), the manufacturer or the company that wrote the software for the AV’s comput-ers? One option would be to create a no-fault fund that compensated victims in AV acci-dents, possibly modeled after the federal gov-ernment’s Vaccine Injury Compensation Pro-gram. Vaccine makers pay a 75-cent tax for every dose purchased (which is presumably passed through in the price of the vaccine) and are thereafter exempt from suits. Note that the rationale would be quite similar: As with vaccines against communicable diseases, much of the benefit of AVs would be reaped by third parties.

* * *The journalist Tom Vanderbilt reminds us

in a recent issue of Wired magazine that Karl Benz, a founder of Mercedes-Benz, once la-mented that the market for automobiles would be limited by the lack of qualified chauffeurs. Today, Bill Krenik, chief technolo-gist for the semiconductor manufacturer Texas Instruments, argues that the advent of autonomous vehicles will be as transforma-tive as the shift from the horse to the internal combustion engine was in a prior era. And just as it once seemed unimaginable that we could drive vehicles ourselves, today it seems unimaginable that machines could drive them for us.

http://www.dailymail.co.uk/sciencetech/article-2633237/Europe-set-win-race-driverless-cars-New-global-treaty-means-automated-vehicles-EU-roads-far-US-gives-ahead.html

http://www.nationaljournal.com/tech/who-gets-sued-when-your-robot-car-crashes-20140325

http://www.nhtsa.gov/About+NHTSA/Press+Releases/U.S.+Department+of+Transportation+Releases+Policy+on+Automated+Vehicle+Development

http://www.nhtsa.gov/About+NHTSA/Press+Releases/U.S.+Department+of+Transportation+Releases+Policy+on+Automated+Vehicle+Development

http://www.brookings.edu/research/papers/2014/04/products-liability-driverless-cars-villasenor

http://www.hrsa.gov/vaccinecompensation/index.html

http://www.hrsa.gov/vaccinecompensation/index.html

http://www.wired.com/2012/01/ff_autonomouscars/all/

http://www.itif.org/events/social-and-economic-case-autonomous-vehicles


tk

As any student of recent economic history can tell you, when housing markets stumble, whole economies can fall. The latest cautionary tale is from South Korea, whose current economic woes have been compounded by its residents’ unusual method of renting apartments.

A


tk

South Korea’s economy, for so long the wonder of East Asia, is stuck in first gear – the second-quarter growth rate of 3.6 percent was alarmingly slow – thanks to lackluster consumer spending. And, as they tend to do, policymakers are looking for a short-term fix in the teeth of long-term problems.

Keeping Up With

the Jeonse

by matt phillips


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MATT PH I LLI PS, a former reporter for the Wall Street Journal, is markets and finance editor for Quartz, an online magazine specializing in business news.

In July, officials loosened mortgage-lend-ing restrictions at banks in an effort to boost the housing market, which has had four straight years of price declines in Seoul, the largest housing market in the country. The government also plans to increase tax deduc-tions for spending on credit and debit cards in an effort to prod the populace toward the check-out register.

There’s a catch, though: South Koreans are in no position to go on a borrowing binge. In fact, they’ve already gorged. Since the end of 2004, total household debt outstanding has surged by 107 percent. At the end of the first quarter it stood at a record high of 1,035 tril-lion won (roughly $990 billion), or almost $20,000 per person.

As a share of disposable income, household debt rose from 131 percent in 2002 to 164 per-cent at the end of 2012, the most recent year for which data are available from the OECD. That’s far above the 135 percent average for the developed economies tracked by the OECD.

Of course, low interest rates – a global phe-nomenon – mean the monthly payments on this debt remain relatively modest. And South Korea isn’t alone in bulking up on debt. Many countries – including the supposedly prudent Scandinavian nations – have high levels of household debt, too. South Korea is different, however. Unlike Scandinavians, South Kore-ans aren’t borrowing to buy houses; increas-ingly, they’re borrowing simply to rent them.

It all has to do with a highly idiosyncratic convention of the South Korean rental mar-ket: Many tenants who lease apartments don’t actually pay rent. You read that right. They don’t make monthly payments.

Don’t start planning your move to Seoul just yet, though. There’s a big catch. To get one of those apartments, you need to plunk down, on average, the equivalent of almost $300,000. Under the country’s jeonse (sometimes trans-literated as chonsei) system, tenants lend sig-nificant chunks of money to landlords in lieu of rent. (Jeonse is usually translated as key money.)

It works like this. In exchange for access to the property for a specified term – usually two years – tenants make a lump-sum deposit to the landlord, based on a percentage of what it would cost to buy the property. The transaction is essentially a loan, with the ten-ant as the lender, the landlord as the borrower, the interest foregone to implicitly cover the rent, and the house as the collateral.

Jeonse contracts have deep roots in Korea’s history; indeed, they can be traced back sev-eral hundred years. But their popularity grew sharply in the 1960s and 1970s. Amid the country’s rapid transformation into an urban, industrialized economy, South Korea faced two large problems: housing rural residents arriving in cities and financing economic ac-tivity. The jeonse system was an elegant solu-tion to both.

“On the one hand, it’s a household rental system,” explains Hyun Song Shin, a professor of economics at Princeton who has studied jeonse. “But actually it’s an informal lending scheme as well.”

t h e j e o n s e

The Jeonse system might have been

something of a

secret weapon

powering Korea’s

rapid economic

development.

http://www.qz.com

http://news.mk.co.kr/english/n

http://www.princeton.edu/~hsshin/


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Shin has a hunch that the system might have been something of a secret weapon pow-ering South Korea’s rapid economic develop-ment. Savings rates surged from the 1960s into the 1990s, in part, he argues, because people socked away significant sums for jeonse money. The system efficiently chan-neled that money to Korean landlords, many of whom were also small-business owners and entrepreneurs, and happy to forgo rent in favor of a lump sum to invest in their busi-nesses. During the financial crisis of the 1990s, the system only became more en-trenched as it allowed South Koreans to by-pass a deeply troubled banking system.

Jeonse worked well for decades, as rising home values and high interest rates made it relatively simple for landlords to take the cash that renters handed them and invest it in a way that would yield high returns. But the dy-namic has recently changed. Household sav-ings rates, which had hovered above 20 per-cent for much of the 1980s and 1990s, have dropped sharply, to under 5 percent. At the end of 2012, the last year for which data are available, the rate was a meager 3.5 percent.

So, what happened? The short explana-tion: In the wake of the Asian financial crisis, South Korea’s banks started lending big to in-dividuals. Between 1998 and 2009, household debt increased by about 13 percent annually,

far more rapidly than the growth rate of the economy. And as it’s gotten easier to borrow, South Koreans have had less incentive to save. That’s transformed the jeonse from a vehicle to build personal savings into something quite different. “If you don’t have the jeonse deposit, you actually go and borrow it from the bank,” said Shin, who this year took a po-sition as head of research at the Bank for In-ternational Settlements in Switzerland. “And that used to never happen.”

The view from the proverbial trenches is instructive. When Minwoo Park, a 33-year-old software engineer, rented his three-bed-room apartment in Seoul’s Yeongdeungpo [CQ] district, he borrowed the lump sum needed for a jeonse contract from a bank. From his perspective, it made a ton of sense. Thanks to low interest rates, his monthly pay-ment amounts to roughly one-quarter of what it would cost him to rent a comparable apartment. “It’s a better deal,” Park says. “Ev-eryone prefers jeonse.”

Not everybody can score as good a deal as Park, who was easily able to get a loan for the jeonse payment thanks, in part, to the solid sal-ary he earns working in the mobile advertis-ing industry. (He declined to offer specifics.) But the current economics of the jeonse are a clear win for tenants. Stagnant South Korean housing prices have pushed more would-be buyers to hold off on purchases. Many of them have opted for jeonse apartments as they wait for housing to recover. That’s boosted de-mand for jeonse apartments. And with supply constrained – landlords aren’t as eager to let all the gravy go to tenants – jeonse prices are soaring. “Now the jeonse is kind of a problem,” said Dongrok Suh, a Seoul-based partner at McKinsey and Company.

Jeonses aren’t risk-free; they’re loans, and sometimes loans don’t get paid back. Of course, jeonse tenants have some protection:

t h e j e o n s e

Most landlords of Jeonse

are now no longer entre-

preneurs who have access

to investment projects

with high returns.

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If the landlord defaults on the contract and doesn’t return the jeonse on schedule, the ten-ants are entitled to get it when the house is sold.

But remember, the jeonse is a lump-sum payment, based on a percentage of the house’s value. Traditionally, that percentage was somewhere between 40 and 60 percent. That provided the tenant/lender with a large mar-gin of safety in case of default. But as demand for jeonse apartments has risen, so has the percentage landlords are asking tenants to pay. That figure is now often between 70 and 80 percent – and in some instances has reached 90 percent, leaving a much smaller safety cushion.

Moreover, many landlords simply don’t have the cash to pay back their tenants. Citing a Bank of Korea report, the Economist re-cently noted that 10 percent of the country’s 3.7 million jeonse landlords could have diffi-culty repaying the money they owe to tenants. In other words, they are stuck in the system because they need to find another jeonse ten-

ant in order to pay off the previous occupant.But the jeonse is problematic for the South

Korean economy for reasons beyond the risk of a cascading financial bust. For one thing, the rising size of jeonse payments sucks more and more money out of productive invest-ment. “In the past, jeonse security deposits were used to build additional houses, or in-crease business investment,” wrote analysts for Nomura, the Japanese financial giant.

“Most landlords of jeonse are now no longer entrepreneurs who have access to investment projects with high returns.”

Note, too, that higher jeonse payments also siphon cash from the consumer sector – a problem at a time when the South Korean economy is operating at less than capacity.

The government is trying to wean South Koreans from the jeonse system through a se-ries of policy changes. It has moved to make some component of ordinary rental pay-ments tax deductible, reducing the financial advantage of the jeonse option. It’s also easing

http://bambooinnovator.com/2014/01/22/koreas-jeonse-money-exceeds-90-of-sale-price-for-76000-households/

http://www.economist.com/news/finance-and-economics/21596566-landlords-are-having-ditch-century-old-rental-system-lumping-it


tax burdens on landlords in an effort to coax more building owners to switch from the jeonse system to conventional rental arrange-ments. “By lessening the burden of those pay-ing monthly rent and decreasing the demand” for jeonse, the Ministry of Land, Infrastruc-ture and Transport explained in a press re-lease, “we expect to lessen the discrepancy in the market and stabilize the prices.”

There are signs that things are moving in the direction that the government is hoping for. The share of South Korean apartments rented under monthly payments is increasing, though jeonse contracts still account for a lit-tle over half. Meanwhile, there are signs of life in the South Korean housing markets. The av-erage price increased by 0.9 percent in the first six months of 2014, after a 0.2 percent decline in 2013, according to Kookmin Bank, one of the largest mortgage lenders in the country.

But more broadly, critics argue that the government’s plan to push people away from renting homes and back into buying them is a short-term fix that won’t solve the underly-ing problem. South Korea is subject to some of the most disruptive demographic trends among advanced economies.

In part, this is to be expected: As countries grow wealthier, birthrates typically fall. But the drop-off in South Korea has been precipi-tous. Since the 1970s, the national birthrate has fallen by roughly two-thirds, to just 1.2 births per woman of child-bearing age – the lowest among all developed economies.

Moreover, the declining birthrates have been accompanied by other signs of growing societal stress. Suicides have soared: South Korea’s rate, 25.9 per 100,000 people in 2011, made it the highest among the countries tracked by the World Health Organization. Divorce rates have also risen, even as the number of couples getting married has been

slipping. The prospects for young people have grown so grim that 20- and 30-some-things have invented a new term, sampo-jok, which translates loosely (according to the Korea Times) as “those who have given up on three things – dating, marriage and children – due to economic reasons.”

That doesn’t bode well for consumption growth; typically, much consumer spending is done during the early years of starting a family, when people buy houses and cars. And it likely won’t be fixed by pushing the country further into debt. The high cost of living – in-cluding outsized spending on jeonse pay-ments and sky-high educational costs – is seen as one of the prime reasons young cou-ples put off marriage and have fewer children when they do tie the knot. “There is a direct link between this financial insecurity and South Korea’s declining birth rate,” wrote McKinsey Global Institute analysts in a recent report on South Korea’s growth prospects.

South Korea’s president, Park Geun-hye, gained office in early 2013 in part on the back of vows to ease the nation’s economic malaise – in particular, the growing strains of a heavily indebted middle class. And she has taken some action, including establishing a largely sym-bolic “national happiness fund” to help some South Koreans refinance their debt at lower in-terest rates, and pushing the fiscal stance of the country toward expansionary spending.

But when push comes to shove, South Korea seems to be taking the position that the solution to the economic doldrums is another round of consumer borrowing. That would be awfully convenient. As the recent experi-ence of the United States suggests, though, coaxing over-extended borrowers to go back to the bank for more is tough, no matter how enticing the terms. And that could mean South Korean efforts to rekindle growth might not bear fruit for quite some time.

t h e j e o n s e

http://koreajoongangdaily.joins.com/news/article/Article.aspx?aid=2985576

http://www.koreatimes.co.kr/www/news/nation/2014/07/511_160519.html

http://www.mckinsey.com/insights/asia-pacific/beyond_korean_style

http://www.mckinsey.com/insights/asia-pacific/beyond_korean_style

http://www.economist.com/news/finance-and-economics/21603047-korean-households-are-struggling-under-mounting-debt-hole-won


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look who’s arrived!In September, Edward DeMarco joined the Institute’s Center for Financial Markets as a senior fellow-in-residence to drive the Cen-ter’s work on housing finance reform and housing policy issues. It’s a subject he knows better than almost anyone; until earlier this year, he was acting director of the Federal Housing Finance Agency, overseeing the op-erations of the giant government-sponsored mortgage intermediaries, Fannie Mae and Freddie Mac. As their conservator, he directed the formidable effort to stabilize their finan-cial condition, even as they shouldered much of the burden of supporting U.S. housing fi-nance in the wake of the market meltdown.

Said DeMarco: “I look forward to speak-ing and writing on housing policy from the Milken Institute’s influential platform.” And we’re looking forward to having a colleague with such deep knowledge of this critical sector.

africa risingIn August, President Obama hosted the U.S.- Africa Leaders Summit, bringing 50 heads of state to Washington for three days of discus-sion. Our burgeoning Africa Initiative was in town too, holding a corporate and investor roundtable that brought together a host of entrepreneurs, government officials and in-vestors from both the United States and Af-rica. The range of topics included governance, the perceptions and realities of investing in Africa, and the ongoing development of capi-tal markets on the continent. Candor and passionate engagement were the orders of the day; the discussion will help inform our up-

coming Africa-related research and program-ming on capital market development and in-frastructure finance.

the east is (in the) blackWant to know the strongest urban economies in Asia? So did Institute researchers, who re-cently released the “Best Performing Cities Asia 2014” study. Modeled on the Institute’s annual, ever-popular index of the economic performance of U.S. cities, our researchers had to overcome myriad research and statis-tical challenges posed by cross-border data comparisons.

The top metro by their criteria? Shenzhen, China – a fitting victor, as the city was the birthplace of the PRC’s transition initiative over three decades ago. To discover the rest of the top 10, check out the full report on the In-stitute website.

Shenzhen, China


l i s t s

I’m okay, you’re better?Creating indexes of national well-being are all the rage among social scientists these days, an

outgrowth of the belated realization that men and women do not live by GDP alone. While

comparisons between countries/places are problematic – both the choice and weighting of

index components (personal safety, income, education, pollution, etc.) are somewhat arbitrary

– much of the fun is in the ranking. (Probably the boldest effort is the Legatum Institute’s

Prosperity Index, which ranked 142 countries in 2013.)

The new OECD Regional Well Being website takes a different tack, scoring all OECD coun-

tries and hundreds of regions within them by eight criteria (best = 10). It doesn’t calculate

overall rankings, but does provide tons of ancillary data. Here’s a small sampling that allows

myriad interesting comparisons. Among other striking points: Many U.S. states (though hardly

all) stand up well in comparisons to affluent countries. — Peter Passell

CIVIC ACCESSIBILITY EDUCATION JOBS INCOME SAFETY HEALTH ENVIRONMENT ENGAGEMENT TO SERVICES

United States . . . . . . . . . . . . .8.5 . . . . . . . . . 6.7 . . . . . . 10.0 . . . . . . . . 8.2 . . . . . . . . . 5.7 . . . . . . . . . . . .7.2 . . . . . . . . . . . . . . . .5.0 . . . . . . . . . . . . . . . 6.8

California . . . . . . . . . . . . . .8.1 . . . . . . . . . 5.4 . . . . . 10.0 . . . . . . . . 2.9 . . . . . . . . . 7.8 . . . . . . . . . . . .7.9 . . . . . . . . . . . . . . . .3.4 . . . . . . . . . . . . . . . 6.9

Iowa . . . . . . . . . . . . . . . . . . . .9.6 . . . . . . . . . 9.1 . . . . . . . .9.5 . . . . . . . . 8.7 . . . . . . . . . 6.4 . . . . . . . . . . . .6.6 . . . . . . . . . . . . . . . .5.8 . . . . . . . . . . . . . . . 7.2

Mississippi . . . . . . . . . . . .8.1 . . . . . . . . . 5.3 . . . . . . . .7.2 . . . . . . . . 0.0 . . . . . . . . . 1.3 . . . . . . . . . . . .8.3 . . . . . . . . . . . . . . . .6.9 . . . . . . . . . . . . . . . 4.7

New York . . . . . . . . . . . . . .8.7 . . . . . . . . . 6.3 . . . . . . 10.0 . . . . . . . . 4.4 . . . . . . . . . 7.5 . . . . . . . . . . . .5.7 . . . . . . . . . . . . . . . .3.6 . . . . . . . . . . . . . . . 7.2

Texas . . . . . . . . . . . . . . . . . . .8.1 . . . . . . . . . 7.0 . . . . . . . .9.3 . . . . . . . . 3.3 . . . . . . . . . 5.2 . . . . . . . . . . . .8.3 . . . . . . . . . . . . . . . .2.6 . . . . . . . . . . . . . . . 5.6

Vermont . . . . . . . . . . . . . . .9.7 . . . . . . . . . 9.3 . . . . . . . .9.5 . . . . . . . . 8.7 . . . . . . . . . 6.9 . . . . . . . . . . . .8.3 . . . . . . . . . . . . . . . .4.6 . . . . . . . . . . . . . . . 7.8

France . . . . . . . . . . . . . . . . . . . . . .7.0 . . . . . . . . . 5.5 . . . . . . . .5.5 . . . . . . . . 9.7 . . . . . . . . . 8.9 . . . . . . . . . . . .5.4 . . . . . . . . . . . . . . . . 7.4 . . . . . . . . . . . . . . . 7.3

Germany . . . . . . . . . . . . . . . . . . .8.5 . . . . . . . . . 8.3 . . . . . . . .6.0 . . . . . . . . 9.9 . . . . . . . . . 7.3 . . . . . . . . . . . .4.1 . . . . . . . . . . . . . . . .5.7 . . . . . . . . . . . . . . . 8.2

Japan . . . . . . . . . . . . . . . . . . . . . . .7.6 . . . . . . . . . 9.2 . . . . . . . .4.7 . . . . . . . . 9.9 . . . . . . . .10.0 . . . . . . . . . . . .4.5 . . . . . . . . . . . . . . . .3.3 . . . . . . . . . . . . . . . 6.9

South Korea . . . . . . . . . . . . . . .7.5 . . . . . . . . . 7.8 . . . . . . . .3.3 . . . . . . . . 9.3 . . . . . . . . . 8.2 . . . . . . . . . . . .0.0 . . . . . . . . . . . . . . . .6.5 . . . . . . . . . . . . . .10.0

Sweden . . . . . . . . . . . . . . . . . . . .8.0 . . . . . . . . . 8.0 . . . . . . . .4.7 . . . . . . . . 9.9 . . . . . . . . . 8.2 . . . . . . . . . . . . 7.7 . . . . . . . . . . . . . . . .8.2 . . . . . . . . . . . . . . . 8.9

Poland . . . . . . . . . . . . . . . . . . . . . .9.6 . . . . . . . . . 4.6 . . . . . . . .1.5 . . . . . . . . 9.5 . . . . . . .2.8 . . . . . . . . . . . .2.9 . . . . . . . . . . . . . . . .1.3 . . . . . . . . . . . . . . . 5.9

source: OECD

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http://www.prosperity.com/#!/?aspxerrorpath=%2Ftheindex.aspx

http://www.oecdregionalwellbeing.org/

The Milken Institute Review • Fourth Quarter 2014

volume 16, number 4

the milken instituteMichael Milken, ChairmanMichael L. Klowden, CEO

Paul H. Irving, President

publisherConrad Kiechel

editor in chiefPeter Passell

art directorJoannah Ralston, Insight Designwww.insightdesignvt.com

managing editorLarry Yu

ISSN 1523-4282

Copyright 2014


Santa Monica, California

The Milken Institute Review is published

quarterly by the Milken Institute to encourage

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The M

ilken In

stitute Review • Fou

rth Q

uarter 2014 • volume 16, n

umber 4

jason furman On inequality

The poor need not always be with us.

dani rodrik On Africa’s economic prospects

Don’t pop the champagne corks just yet.

robert looney On Puerto Rico’s economic nosedive

Does bankruptcy loom?

matt phillips On Korea’s system for housing finance

Too clever by half?

robert moffitt On America’s safety net Could be a lot worse…

larry fisher On state franchise laws

Government as the enemy of competition.

jayson lusk On Frankenfood

Misunderstood, like the monster.

rob atkinson On driverless cars

The Jetsons are at the door.

In this issue

Challenging Inequality

Fourth Quarter 2014Fourth Quarter 2014

Documents

In this issue - Milken Institute · PDF fileincluding a ground-breaking index of the best performing cities on the continent. ... fundamentals have improved, ... netic engineering